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Market Drop Likely - Here Is A Great Trade With Limited Risk and Great Upside

Posted by Pete Stolcers on November 21

Posted 9:30 AM ET – Yesterday we had the biggest market drop in a month. That sounds like a big headline, but in reality the move was small. Concerns that a US/China trade truce might not happen this year are surfacing. I’ve been mentioning this and I believe the negotiations are going to hit a brick wall today or tomorrow. Trump will support the pro-democracy protests in Hong Kong and China will be infuriated. The market is pricing in a trade truce and I believe bullish speculators are about to get flushed out.

Yesterday the House unanimously approved the Senate bill supporting Hong Kong protesters. Trump will be forced to weigh in and he could sign the bill as early as today. China condemned the legislation and threatened unspecified retaliation and “strong countermeasures”. The Chinese Communist party’s official newspaper (the People’s Daily) said that if the US sides with protesters China will inevitably adopt forceful measures to take resolute revenge, and all consequences will be borne by the United States.

This development is a likely speed bump for the market. Bullish sentiment is high and speculators are about to get flushed out. Good news is priced into the market and stocks are trading at a forward PE of 17.5. That is at the upper end of the valuation range and Asset Managers have been passive buyers. The FOMC minutes yesterday confirmed that the Fed will not cut rates again until economic conditions deteriorate. Given all of these inputs I believe we are due for a round of profit-taking. It will be sharp and swift.

Earnings season is over and the economic calendar is light.

Swing traders should buy a full position of VXX on the open today. It is at a 52-week low and it will spike on any market pullback. The pre-open value is $17.60. When you are filled, place an order to sell at $21. Also place an order to buy a half position of SPY at $303. I want to buy a dip to that level and I believe we could see one in the next couple of days. If you have been selling bullish put spreads, I suggest taking some profits and reducing risk. I feel much more comfortable selling bearish out of the money call spreads. I view the backdrop as neutral to slightly bearish right now. In last night’s weekly Swing Trading Video I highlighted some good bearish call spreads. I used Option Stalker to find them and these stocks were on a sell signal (daily, four hour and two hour basis) and they had relative weakness (daily, four hour and two hour basis). In particular I like stocks that recently rallied through resistance and then fell back below that level. Sell bearish call spreads above that resistance and use that level as your stop. In the video I also highlighted bullish stocks. Have your bullish lists ready to go. When we get the market drop it won’t last long and you have to be ready to sell bullish put spreads. This will be our last opportunity for a good entry point for the rest of the year and I suggest selling the December expiration.

Day traders should avoid the long side today. Trump’s support for the protesters could come at any time so I am trading from the short side. If you shorted the market yesterday as I advised, you made a lot of money. I bought puts before the drop and I took profits on half of my position yesterday. I am looking to add to the position this morning to get it back to its original size. Chinese stocks and cyclical stocks will be particularly vulnerable to profit-taking. Heavy Selling, 4 Bar Breakout and Relative Weakness 30 are my favorite Option Stalker searches. In the first 10 minutes I know which stocks I’m going to be focusing on. That’s critical since the majority of the move happens in the first hour.

Swing traders should buy some VXX. I see the downside is very limited and nice upside to this trade if we get a market decline. Also have an order ready to buy if the SPY drops to $303. Day traders favor the short side. The price action on these stocks has been good and you could have a windfall if Trump weighs in on the protests.
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