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*Rare Extended Irrational Market*

 
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PostPosted: Sun Oct 29, 2006 9:32 am    Post subject: *Rare Extended Irrational Market* Reply with quote

SPX had a classic October to May rally where it rose from 1,168 to 1,326. A correction then took place to where SPX reached 1,219 in June. Almost everyone believed there would be a low trading range, e.g. between 1,180 and 1,280, perhaps through October. However, SPX created a double bottom, around 1,220, and rose to about 1,390. When SPX rose above 1,280 and 1,290, which were major resistance levels, I was one of the first to predict it would rise to 1,350, although I found my own prediction hard to believe. While SPX moved higher, others predicted upper targets of 1,355 and 1,360. When SPX rose above 1,360, the term "melt-up" began to be used.

SPX rallied strongly throughout the seasonally weak period of September. Also, intermediate-term technical indicators became unclear, e.g. the NYSI reaching a higher high for the first time over the four-year cyclical bull market. Moreover, short-term technical indicators became unreliable, e.g. the TICK 100 and 200 unit MAs, which held extremely overbought levels for weeks. The TICK 200-unit MA was often above 300 for many weeks, and over the past week or so traded around 350. On Friday morning, the TICK MAs reached the following levels when SPX was down roughly five points: 200-unit 386, 100-unit 427, 50-unit 502, and 20-unit 616. SPX closed over 11 3/4 points lower Friday, and the TICK 200-unit MA still closed above 365 and the 100-unit MA closed above 390. However, sentiment indicators were consistently market bullish.

Over almost all of October, the pullbacks became even more shallow. Consequently, the prices of puts fell sharply on the rising market, time value decay, and an implosion of implied volatilities. Moreover, the shallow pullbacks didn't allow opportunities to sell some puts to lower average cost or bail-out. Any previously reliable information became worthless. I knew a potential worst case scenerio was shaping up at SPX 1,350. So, I planned to move my portfolio, which was heavily weighted in puts, into a neutral position on a pullback to the first significant support level at 1,338. Unfortunately, SPX basically traded flat for several days and then moved sharply higher. SPX continued to rise with even more shallow pullbacks over the next few weeks and reached about 1,390.

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