Daily Form August 20, 2008

Profit Patterns and Risk Management For Active Traders
Trade successfully without having to be right about the underlying market direction
WEDNESDAY AUGUST 20, 2008       07:31 ET

The current preoccupation for many traders is whether the turning point in the financial services on heavy volume in mid July marked a real base for the sector or not. As the chart below for the XLF fund shows there was a major inflow of capital to the sector on and around July 15th and the recent retreat, including that seen yesterday, has not been accompanied by such substantial volume. Nevertheless, perhaps taking the cue from some gloomy prognostications from a former Federal Reserve governor who predicted that a "whopper" investment bank in the US was sure to fail and negative reports about Lehman Brothers (yet again), traders on the short side, especially the large hedge funds, took another swipe at all of the usual suspects.

What is hard to estimate is just how much of a doomsday scenario is already priced into companies like Merrill Lynch (MER), Citigroup (C) and the regional banks (RKH). I suspect that we will find out fairly soon whether July 15th did in fact mark a major inflection point for the sector. A very heavy volume session with shorts scrambling to cover as we approach the $18 level on the XLF chart could signify the market’s belief that, no matter what new major surprises there are in store for the banks, the Fed and US government, as well as strategic global holders of dollar assets, will continue to remind investors of the fact that there is an implicit public sector underwriting of private sector liabilities in the financial system.

The VIX underlines the fact that there is far less fear in the market of any imminent financial collapse than there was in March and even in early July.

The investment banking index (^XBD) has broken below an important trend-line suggesting lower prices ahead, but in line with previous commentary the suggestion is that the decline may be more orderly and persistent rather than climactic.

The FTSE 100 index (^FTSE) suffered relatively more in yesterday’s decline and the break below a key trendline which now points to a re-test of the July low and also continuing under-performance for the UK index.


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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PPH  Pharmaceutical HOLDRS  

PPH, an ETF that tracks the pharmaceuticals is flashing a buy signal from pattern recognition algorithms and the recent pullback has been on very light volume.

IGV  iShares Software ETF  

Another sector fund that I would favor on the long side after a further pullback is IGV which tracks equities in North American Technology and Software