Not Looking Good

Dow to Re-Test March Lows?

By Bryan Bottarelli
Wednesday, June 11, 2008 10:43 AM EDT
Wed, 11 Jun 2008 14:43:00 GMT

Dear Bottarelli Research Member,

I’m not going to lie: The major market averages do not look healthy.

Today’s move under the 12,200 level on the Dow could indicate that the Blue Chips will soon re-test the March 2008 low at 11,800. And as I indicated yesterday, that means another 400-points of downside could be in the cards.

INDU

When faced with this situation, I’d like to clear out the entire trading ledger. Therefore, after taking profits in our Visa (V – NYSE) puts this morning, let’s also close out our DE June 80 Calls (DE FP).As I mentioned yesterday, the current market environment is just too dangerous to navigate. Smart trading decisions are now being overtaken by emotions, and environments like this are never suitable for logical trading. Therefore, the smart move here is to shove away from the table and let any turmoil sort itself out.

As a follow-up to that point, I’d like to introduce a new tactical strategy that surrounds around the values of the Volatility Index (VIX).

VIX

Looking at our performance record, its’ clear that times of irrational and emotional trading correspond with large price jumps on the VIX. As you can see from the VIX chart, two of these recent VIX price jumps occurred in mid-March and here in mid-June, and that’s when our trading results did not live up to our historical performance. Therefore, it became clear to me that whenever we witness a VIX price jump of 20% (or more) in a matter of days, that’s an indication that emotional trading is now dominating the market.

When we get this signal, we’ll implement two new tactical positioning strategies. The first will be to reduce our contract sizing. For example, times of increased volatility will require you to cut your position sizes in half. If you typically trade 4 contracts, you’ll now trade 2 contracts. And second, we’ll reduce the frequency of our trading. If I typically issue one new trade per day, I’ll now issue one new trade every two days.

In my view, both of these tactical strategies will allow us to reduce our exposure during times of heightened volatility — and in the process — help us to achieve higher returns. So going forward, I’ll see to it that these new rules for market volatility govern our daily trading activities. After all, taking the proper steps to correctly limit our risk in a dangerous market environment could tremendously improve our yearly trading returns, and following these two rules will certainly help us to achieve this goal.

So in that spirit, I’ll be carefully watching the markets over the next two days, but I don’t plan in taking on any new plays. Let’s allow this market time to sort itself out, and as the VIX falls back down, we’ll be in a much better position to lock in steady and consistent winners. Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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