If the recent market volatility and overall abysmal performance has taught me anything this year, it's that the false rallies not just a cruel joke to long investors, but they also provide for nice trading opportunities. If anyone's been lulled into complacency by the past two days' rallies following the announcement of Obama's financial team, they're likely drinking the cool-aid CNBC's been serving (anything to reignite interest in the market = ad revenues!).


Given the extreme volatility of the Financial ETFs especially, I've made some moves in and out of the SKF 2X Inverse Financial ETF and the UYG 2X Long Financial ETF. In this recent play, while I didn't take full advantage of the peaks and valleys exhibited over the past few weeks, I was able to eek out a 13% gain of around $400 by selling at the peak of exasperation on Friday (SKF is negatively correlated and I sold at $293, approximately where it peaked out prior to the huge rally later in the afternoon).

10/10/2008 Bought 16 SKF @ 194.16 -3,116.55

10/22/2008 Sold 8 SKF @ 150.7106 1,195.68

11/21/2008 Sold 8 SKF @ 293.075 2,334.59

In this case, yes, I sold half the shares prematurely to free up some cash and avoid the run down to $120 that ensued the next week, but in this market, I've been resolved to constantly have at least some short/hedged position for when things become just too panicked and dire to ignore, as was the case on Friday when markets reached historic lows, which mandated the unloading of the remainder of the position to free up cash.

Buy the Lows, Sell the Highs

Well, that's as rudimentary as it gets and sounds much easier than it is in practice. I don't claim to be able to time the market better than the next guy. I'm net long of course, especially after a 40-50% market decline and with a long time horizon. However, in my estimation, until housing rebounds, which may be years from now, I don't envision a strong, sustained rally or a return to prior highs. This neat video actually uses some neat Fibonacci series analysis to document some disturbing trends that portend lower levels from here - (I've been enjoying these).


Therefore, today, following two huge days of runups, while I'm net long 90% of the portfolio, I also took a position in the Inverse S&P 500 via ticker SDS. I used to use put options for this purpose when they were inexpensive at a time when the VIX was under 20, but with the VIX at more than triple that, buying options are an expensive proposition. In fact, I've been selling options given the rich premiums.

While somewhat rudimentary, I ran a some calculations for how the market has behaved since September when things really got ugly. In effect, each time the market has seen a 5% runup from the day's close back to the prior close (1 day return), there has been a subsequent significant drop before the same process repeated itself.


Following the 14.5% runup on 10/13, the market dropped 7.8% before the next big pop.


Following the 6% runup on 10/20, the market dropped 15.9% before the next big pop.


Following the 11.7% runup on 10/28, the market dropped 8.3% before the next big pop.


Following the 6.2% runup on 11/13, the market dropped 18.3% before the next big pop.



Now, we've had two runups of over 5% across Friday and Monday. What's next? In my estimation, another downward move of 8-15% and I'm on it with SDS.


In this sheet, I had simply set the absolute value to the day over day closing % gains and culled out days over 5% and summed the subsequent days' returns.

I also recommend checking out these videos on profiting from volatility; very good stuff, I've been watching these, just put your email in for updates!

Disclosure: The author is long UYG, has short puts on UYG, Long SDS and is net long in the trading portfolio which contains other equities and derivatives.

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