Daily Form August 20, 2007

Profit Patterns and Risk Management For Active Traders
Trade successfully without having to be right about the underlying market direction
MONDAY AUGUST 20, 2007       05:44 ET

Inevitably there was an enormous amount of commentary over the weekend regarding the Fed’s decision to cut the discount rate and the consensus view seems to be that the Fed will intervene again sooner rather than later to cut the fed funds rate by perhaps 50 basis points. The most astute insight that I encountered in my review of the decision was in answer to the rather obvious question - why would a bank want to borrow at the discount rate when the fed funds rate is (even after the cut) half a percent lower? Symbolism issues aside the most telling point is that collateral requirements for borrowing at the discount rate are less stringent for banks and other companies such as mortgage lenders than they are for qualifying for repos at the fed funds rate.

The implication is that many financial institutions need to borrow against mortgage backed securities rather than Treasuries which are the most common collateral for fed funds borrowing. Since the market in MBS’s has frozen the Federal Reserve is fulfilling its role as the lender of last resort to some distressed companies laden with securities that are being shunned by the interbank market. Another feature of Friday’s discount rate cut, and buried in the small print of the Fed’s decision, was the fact that they are also providing a facility for up to 30 days on borrowings which gives additional margins for comfort during this period of unusually illiquid money markets.

A lot of attention will inevitably be focused this week on signs that the Greenspan put had been reincarnated as the Bernanke put, and we may see an outright deliberate ploy by some traders to test how readily a safety net might be provided.

Reviewing the chart for the S&P 500 (^SPC) the index made a strong move in response to the cut but now needs to cross above the 200 day EMA. Noticeably in Friday’s trading the CBOE Volatility Index (^VIX) ended the session higher than it opened and it is a fairly safe assumption that unusually erratic price moves and intraday volatility will be a recurring feature of trading again this week.

The chart for the Russell 2000 (^RUT) reveals a very striking spinning top with a strong opening gap upwards. The index reached up to the 200 day EMA but closed almost exactly in the middle of the daily range.

As discussed in Friday’s commentary the banking stocks triggered the short squeeze that caused Thursday’s dramatic intraday turnaround and they continued further upwards in Friday’s session. Over two sessions the index has regained more than eight percent and some consolidation may now be expected as the index faces chart resistance at 112 and from the 200 day EMA which lies not far above that level.

The Nikkei 222 (^N225) concluded Monday’s session with a three percent gain and perhaps not surprisingly in conjunction with Friday’s long red candlestick, resulting from the more than five percent down move on that day, an inside day was registered. The long upper tail to Monday’s pattern suggests that institutional caution is still being encountered and that some are taking advantage of higher prices to continue liquidations. Once again it will be wise to keep the USD/YEN exchange rate on your screens this week.


The patterns identified below should be considered as indicative of eventual price direction in forthcoming trading sessions. None of these setups should be seen as specifically opportune for the current trading session.
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FFIV  F5 Networks Inc  

The chart for F5 Networks (FFIV) exhibits the characteristics of a bear flag formation and the stock faces resistance from the 200 and 20 day EMA’s which are not far from Friday’s close.

GS  The Goldman Sachs Group Inc.  

An intermediate term target for Goldman Sachs (GS) would be in the region around $200 but it almost certainly will not be a smooth ride.

AAP  Advance Auto Parts Inc.  

Advance Auto Parts (AAP) appears to be in the early stages of a recovery process and the selling climax that took place on August 9th has given way to some positive money flow divergences.