The Fan-Fred Rally – Day 1 of 1

You might think that I am being stingy by giving this government-sponsored rally only one day. But in fact, I am being generous. After all, is it really a rally when the QQQQ finishes down 0.37%?

Traders seem to be unanimous in their view that the rally was disappointing, especially when compared to previous Sunday-Surprise rallies, and I agree. So, I will not discuss the rally’s defects except for one aspect.

Everybody was expecting there to be panic buying at the open, but that didn’t happen. I think that the gap-up was so huge that many traders who were prepared to barf up short positions just sat there staring in awe at the huge gap – frozen like a deer in the headlights. And since the selling started only 4 minutes after the open, they just sat back with relief and watched the amazing plunge.

But of course, there is an army of traders which focuses on gaps. So as the market plunged toward the opening gap (SPY at $125.10), the gap-traders went long to play a gap-bounce. In the comments yesterday, I wrote that I thought the gap-bounce would be weak. And it was, but it frightened the frozen shorts who were suddenly in a panic that they missed a good exit point to buy-to-cover and minimize the haircut.

So, when that first gap-bounce rolled over, the frozen shorts rushed in to buy, and that triggered a sharp short-squeeze rally into the close.

Now maybe I am just rationalizing the action since I am short. However, we have some proof that the above theory may be true: the futures dropped a few points after hours, and then Asian markets opened badly. So, it looks like the afternoon rally was a retracement, and since it was sharp, it was probably mostly panicky short-covering. And as Charlie pointed out in the comments yesterday, it topped out at exactly the 61.8% Fibonacci level of the retracement of the drop from the peak on September 2 to the low on September 5.

Everybody was expecting a massive rally today and this week, but so far, the market looks like it intends to do the opposite. If so, September could be a replay of June. So, I think I will deploy some more of my cash short at the open, just in case.

The market is still clinging to a bear-market rally (not counting tech!) as the economy continues to contract. So, I think taking short positions here is very low risk assuming a holding period of a few weeks or so.

I am short via S&P futures, SPY puts, SDS, and QQQQ puts, and I think I will buy some QID in the morning.

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