Sunday, July 12, 2009

Watch for stop hunting into OPX expiry

When I was a young buck, I worked on a night desk trading currency through New York hours out of Sydney. It was a tough job - not only because the highlight of the night was often re-runs of The Streets of San Francisco (RIP Carl Mulden) - but because it was an isolated existence. All our counterparties were in another part of the planet. We could ‘talk’ via the direct dealer, a screen that enabled 4 conversations simultaneously (this was 1995 - the internet hadn't taken hold yet) but we were effectively alone.

The first task of the night (around midnight) was to call all the AUD desks in London and see how they were seeing things. Now the point of this story is that 9 times out of 10, if they were all saying the same thing (eg. it's going higher), then the opposite would happen (it's lower!). They were all of the same view and positioned accordingly. New York would come in – see the stop loss orders protecting these guys and immediately take them out.

Now the media and blogosphere have been alive over the last week or two with the news that a head and shoulders is developing in the US equities markets. This is a trend reversal pattern – a tradition signaling exhaustion as the smart money sells to the retail investor. It has good form.

If this is the consensus call - my question is where are the stops? My gut is telling me that this week will be the one where they get taken out – and given that 'green shoots' sentiment has trickled lower in cahoots with all this H&S grooming – my guess is that the stops are to the topside.

The Evil Speculator has summarized the levels – have a look at his charts for a sense where the stops may be. For mine, the downtrend channel that comes in around 910 looks like the goods - at worst a quick run-up through that should have everyone short at current levels out of the market. (I also like Fujisan’s observations about the OPX expiry – my experience suggests crowded strikes have a force equivalent to gravity - if the market is close, price will be drawn in…she notes 890 and 900 as having the largest open interest).

After that the way is clear down to 800...

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