While this looked like it would be a ho-hum normal “status update” – through the course of market examination, I have found a massive opportunity, and also a huge warning for anyone playing the Oil or Stock Index trend line breaks of the last two days.

Friday Report – Positions & Potential

Oil Win

I took a short position in oil when it broke the clear uptrend, using patience to wait for a test of the underside.

I closed the puts Thursday as it looked like a clear A-B-C-D-E correction is complete.

Here’s the proof:

At that time my trading account was $1,500, so $600 profit was more than 30% gain overnight. I’ve since deposited substantially more – and I will be looking for the same gain on a big trade coming up.

Stock Indexes – Trend Broken

The stock market seems to have broken the upward trend line / channel and completed a an impulsive 5-wave move up since Christmas. I do not expect this to be a head fake and I think the market will retest the previous 4th wave as a first target.

I took a short position with a hedge on Thursday. My plan is to profit on the downside, but if the market is to make new highs I would hopefully profit that way instead if I hold it long enough. I used very short term (3 weeks) calls that will increase in value quickly as my buffer.

My puts were up decent this morning but running out of downward momentum, so I added to the hedge. I was hoping the market wouldn’t bother retesting the underside of the trend line but it looks like it will.

I have at the money SPY March 15th puts and March 1st & March 15th Calls.

Also interesting, as of Friday morning the Dow had not yet broken its trend line while the S&P had – now they both have.

However the Dow rallied back up above the trend line at close, while the S&P didn’t.

Next Week

Oil and the indexes have seen substantially correlated as I’ve been watching them the last few weeks – when oil is up, so is the stock market. Others have noticed as well. Here you can see an overlay of Oil on the Dow that demonstrates the correlation. The Dow component of this chart is only calculated on close, and you can see on the majority of days the indexes were up, oil was also – and vice versa.  I expect this to diverge from here.

Oil seems to have completed the correction and may be bottoming here, although I have yet to see any definitive impulse to the upside. The proposed 1 here doesn’t look convincing, let’s zoom in.

Ahh, we may have found it, the 5th wave could be truncated. It still wouldn’t explain the messiness in what should be the next 1 wave up…

If we look at that also it looks pretty impulsive, with a pretty solid 5th wave ending diagonal. Here is a great ending diagonal explanation by the way.

I may have identified the bottom in oil – we will know next week.

Our good friends at EWM mentioned the scale of what I have marked as the 4th wave is too large – but on a daily chart it doesn’t loom as large. In that vein I just dove in, Wave 1 was 4.5 while waves A-D of Wave 4 are all less than 3, and the larger E is still smaller than Wave 1 at 4. This confirms to me that the scale is good, and this is in fact, most likely a 4th wave with 5 yet to come.

I am certainly not the only one trading this trend line break, as trend trading is literally the oldest retail trading game in the book. The most people will lose money on a head fake trend line break and ensuing rally, and I think that’s what markets do, is break banks.

If we look closer to see what we can expect time-wise… surprisingly, we can see that if the 5th wave took as long as 3 trading days, it could reach our target and still be UNDER the TREND LINE. If you remember, Wave 1’s rally the day after Christmas was $4.50 in ONE DAY.  

I’m not suggesting anything that hasn’t happened before.

There is arguably a large Inverse Head & Shoulders formed in oil as well – and the market could target 63 from here with a 62% retracement of the overall move down from 76. If we get the blow off I’m expecting, it may come down again rapidly (as most 5th wave blowoffs reverse) – then I think it will move even higher from there.  Or perhaps the blowoff 5th extends itself and we go straight there without a retrace of the 4th wave.

Given Oil’s correlation with the stock market, I am very glad I hedged my index position, although being under the trend line and retesting is normally an IDEAL place to be short. We will see next week.

The question is:

Is the bottom in on Oil? Will we see a 3-day, 5th wave rally?

And will it turn an Index trend line break into a massive head fake? Or will the stock market be scared of skyrocketing oil and continue lower? 

I think we will see a divergence in the oil/stock market correlation – and stocks will go down while oil continues higher.

To be continued.