How is this possible? What’s causing this?

PRE-OPEN MARKET COMMENTS MONDAY – Not one of the people wringing their hands this morning asked, “Why is the market up 40% in the last nine months?” No one questions market rallies, they only question big market drops.

I’ve been warning you to be very careful for the last month. This was a light volume rally and 60% of the S&P 500 gains this year came from a handful of mega cap tech stocks. That is not a healthy backdrop and we went to cash on a swing basis weeks ago. Friday we had the technical confirmation we needed and we started to take some bearish swing trades. I didn’t expect such a large drop over the weekend and I planned to add to short positions this week.

The market rallies much farther than you would ever expect and the market drops much farther than you would expect. I’m not going to repeat all of my technical and fundamental analysis. Watch the videos for the last few weeks and watch the video I posted yesterday. It was posted well before the overseas markets opened last night.

In that video I mentioned taking starter shorts Friday and that you need to be mentally prepared for a bounce. What I forgot to mention is why you would take starter shorts when the chance for a bounce loomed. Sometimes…. you don’t get the bounce and you get a big drop like we are seeing this morning. I had a large futures short position on Friday and I decided to take gains. Initially, I planned to hold the position for at least a few weeks. By the end of the day, I was satisfied with really nice gains and I felt there was a good chance that we would bounce this morning. I thought I would have a chance to reload this week. I was wrong. Am I fretting that I missed a big move? No. I am remembering the satisfaction I had taking gains on Friday. I did hold a fairly large position in JPM puts and they will benefit from the market drop and a spike in implied volatility this morning. I was much more comfortable holding a short position in a stock.

So what do you do this morning?

If you have short positions with monster gaps down you might lock in some of those gains especially on big IV spikes. Don’t hit bids, offer much higher than the opening price and make them come get you. You are in the driver’s seat and many traders will be looking to buy protection. You can short stock, but know that the bid/ask spreads are going to be wide and that the price action is going to be very choppy. Some stocks will be playing catch up. Ideally the stock has not tanked on the open and there will be steady selling pressure. You can short those if there is a major technical support level that is breached. I would avoid shorting big gaps down. Those stocks need to settle down and the chance of a big bounce is high. You do not want to get trapped.

If you have a lot of longs that you need to unwind… ouch. You can short /ES to hedge some of your positions and gradually unwind them over the next few days when the market and the stocks settle down.

If you are in cash, I would not buy puts. They will be incredibly expensive and the bid/ask spread will be a mile wide. Run searches and find stocks that have broken support and that have fairly low IVs. You can run searches for this in Option Stalker Pro and Option Stalker. A value below .35 would be good. Realize the IVs are based on the closing values Friday and not the IVs this morning. Your broker should have a column for IV in the option chains. Financials usually have low IVs and that might be one place to look. Buy October options that are deep in the money. Know that you missed the train. Do not chase big moves. We will have plenty of chances to get short.

I would discourage buying stocks for day trading. That is very risky and no matter how good the stock looks, know that this is the beginning of a market correction and not the end. At any moment, the bottom can fall out of your stock. You were patient and you were in cash. You avoided the big hurt this morning. Don’t make the mistake of going long.

By all means, do NOT enter long term swing trades. We have a few months of selling pressure to get through before that time comes.

THIS NEEDS TO BE YOUR MINDSET FOR THE NEXT TWO MONTHS: “ANY BOUNCE NO MATTER HOW GOOD IT LOOKS IS ONLY A BOUNCE. IT IS NOT A BUYING OPPORTUNITY. THE BIGGER THE BOUNCE, THE BETTER THE SHORTING OPPORTUNITY.” THIS IS HOW WE WANT TO OBLITERATE MAJOR MOVING AVERAGES!

Do not convince yourself otherwise. Stocks will get a lot cheaper than they are now. There are going to be great shorting opportunities and we will catch them. We just have to wait for our windows.

Know that there will be margin calls for over-leveraged traders who are long. They will be forced to exit. Know that shorting VIX has been a very crowded trade and that a huge spike is going to create pain for premium sellers. Know that investors who see a big market drop are going to panic. When they exit their funds there will be some long-term selling pressure. Look beyond our market and know that there is pain elsewhere in the world.

ISM services comes out 30 minutes after the open. That will be an important number and it needs to be well above 50. It came out well below 50 last month (48.8) and that was one of the weakest readings of the year. It is in contraction territory. Analysts are expecting 51.1.

Support is at the 200-day MA and resistance is at the 100-day MA.