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Exaggerated Forecasts As A Contrarian Signal

When markets correct dramatically, as stocks have done since the beginning of the year, the cynical trader side of me comes out in force. I am often tempted to try to pick the bottom, but I will generally not act until I sense a shift in tone amongst the commentators in the business media. For the first 5-8 percent of the decline the usual suspects can be heard reassuring us in smooth voices…”This is just a normal correction and is, in fact, an excellent buying opportunity” they say, before listing tech, healthcare and consumer discretionary as sectors to buy on this “dip”. I don’t know why it is always those three, maybe that that is what they are taught to say at talking heads school or something, but it invariably is.

Once we reach the 8-10 percent decline area and eventually push through 10 percent as we did on Wednesday, the tone begins to change. What we hear then is that this is a “…fundamental revaluation…” or some such thing and the phrase “The decline may have further to go…” that suggests, while trying not to instill panic, that a collapse is imminent. Eventually, and this too hit the U.S news on Wednesday of this week in a report from RBS, somebody goes full on doomsday. In the RBS case the advice to customers was to “sell everything” except high quality bonds. For traders looking for an entry point that is like music to their ears.

It is not that we have definitely seen the end of the declines; it’s just that once responsible people start spouting nonsense like that and individual investors begin to panic out of their stocks, you know that some kind of a bounce is coming. That bounce, which we saw on Thursday, is no guarantee that the S&P will jump straight back up to 2100, but it enables traders to bet on that almost risk free by anticipating that initial move and then locking in a profit with a stop loss above where they bought.

That is basically what happened with me and the Energy Trader Team subscribers this week, but in the NYMini Oil Futures (QM). We had already initiated a short oil position at $33.50 with an aim to reverse to a long at about $30, as I talked about here last week. So, when I heard on Tuesday that Standard and Chartered Bank had predicted $10 oil in the near future I knew that it was time to reverse. The competition amongst analysts as to who could make the most outrageous prediction was surely over, and that meant that a rally was imminent. I sent out an e-mail to subscribers and we reversed to a long position immediately, at $30.10.

(Click to enlarge)

Once again, the fact that somebody predicted $10/Barrel doesn’t mean that we are not going any lower at some point. It just meant that a bounce of some kind was coming. Now, by placing stops just below $30 on that long position, we can bank the 340 point profit from the drop (which on a 10 contract position, with a roughly $22,000 margin requirement, equates to $17,000) and run an essentially risk free long position.

Not every trade works out that well, nor does one exaggerated forecast necessarily indicate a turnaround. If we do consolidate above $30, though, looking to short when the first ” $100/barrel before the end of the year” prediction hits the airwaves will be a good strategy.

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