Thursday, August 17, 2006

Contrarian's View

So bullish out there... And it was just a few days ago when the entire market was screaming "Inflation! Rising rates! Declining house starts! War! Terrorism! Deficit! National debt!"

Then suddenly the tone changed to "Well, we're not in the clear yet but this looks really, really good. The Fed is done. Earnings are great. Screw Middle East. Oil prices are lower."

Yes you've all heard all of this before. Why talk about this banal stuff?

Simple: for a contrarian trader this "stuff" is essential for spotting reversal points. The above are simply sentiment reads and, while admittedly very broad, are very indicative of imminent reversals. I don't want to beat a dead (actually, not so dead at all!) horse, but look at the Housing sector as an example. Mid-July was the perfect buying opportunity amidst trumpteted horrors of collapsing real estate and falling earnings. As crazy as it may sound but buying into that precipitous decline was the only way to trade the sector and those of us who have, have been greatly rewarded.

Going forward, a few things strike me from a contrarian standpoint:
  1. The market is toppy overall but not toppy enough to get short. However, once a flurry of bulish retoric emerges, buying cheap index puts would be the perfect play. This is the only time I would actually warrant buying index options.
  2. The Housing sector isn't done and the latest dip was an excellent re-buying opportunity. There is still a massive overhang of negativity which will produce more buyable dips. By the way, according to Adam, public has been buying calls in the sector in volume. By public I mean non-sell side such as hedge funds and individuals. Weird, huh?
  3. Oil is being quickly forgotten and is nearing at least a temporary bottom. Look to get in below $70 (Sep Crude).
Cheers,
/Dmitry

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