Friday’s Sell-Off a Prelude of Declines to Come

Earnings can only juice the Dow for so long

   

Friday was not a good day! Not only were we down a bunch, but we also had another bad round of news.

But, it is really no big deal. After all, it was an expiration Friday, and these things do tend to happen on expiration Friday, according to options trading articles. We should be fine from here, shouldn’t we? The answers might surprise you and will probably contradict everything you hear on television. But the answers are “no,” and “no!”

You probably heard a lot over the weekend and on Monday about how investors should disregard, or at least discount, Friday’s sell-off as an expiration-related aberration. But evidence shows that expiration day is not any more volatile than any other day, all things being equal.

So, don’t be so foolish as to think that Friday’s action was not important or real. To be honest, there were a few signs that I talked about in my morning calls last week and in my mentoring class. These signs not only gave hints to Friday’s sell-off but that an upcoming sell-off may be a little more serious than the “expiration aberration” explanation given to us by the talking heads.

The week started with a “bang” as earning season got off to a great start. Alcoa and CSX got things started by beating estimates and putting out an upgraded and improved forecast. These reports were followed by similar reports by, among others, Intel. All three stocks gapped up on the opening, but all three traded down from there. J.P. Morgan and Bank of America beat estimates, but investors were not happy with the quality of these earnings and both banks sold off. For the first time in a long while, stocks seemed to find trouble using earnings to boost the market up. The bulls have used previous earnings seasons as launching pads for this rally since 6,500 on the DOW! Could this earnings season be different?

Maybe this is the earnings season where the institutions use the increased strength in demand for equities driven by the “good” earnings — .i.e. beat analysts’ estimates — to lighten their portfolios by selling into the increased demand. If that is true, then it is very possible that there is more to Friday’s sell-off than a simple expiration aberration. The next few days will tell the tale. If we get back up over DOW 10,200 and close there, we will have a good chance to take a run and erase Friday’s big sell-off. Or, we can run back up to DOW 10,200, fail there and then sell off hard. So we are somewhat on a see-saw here until we get a confirmation of one direction or the other.

In this case, if the VIX is low enough — 20 or so — you almost have an opportunity to buy a straddle or a strangle. If the VIX is too high at the time, then the trade may be prohibitive. That decision is up to you, but one way or another, we should get a good movement away from DOW 10,200 in the near future. Personally, my bet is on the downside this time based on the market’s reaction to earnings reports… selling into the strength. We will see what happens!

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Article printed from InvestorPlace Media, http://investorplace.com/2010/07/fridays-sell-off-a-prelude-of-declines-to-come/.

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