Signs of Wave 2- Consumer Confidence Slides

It appears as though the US equity markets have been correcting since June 11, 2009 after recording a 30% rally over 3 months. If someone had bought DIA with $200,000 at the bottom, he or she would have made $60,000 in 3 months. Let's say a person only caught 20% of the rally. Then the person made $40,000. That's one good news. And the other one is that you can still make money as the DJIA retraces in the second wave.

I outlined the wave personality of each wave in the wave cycle on technicalanalysisbase.blogspot.com. CLICK HERE to go directly to the post.

Second waves- Second waves often retrace so much of wave one that most of the profits gained up to that time are eroded away by the time it ends. This is especially true of call option purchases, as premiums sink dramatically in the environment of fear during second waves. At this point, investors are thoroughly convinced that the bear market is back to stay. Second waves often produce downside non-confirmations and Down Theory “buy spots,” when low volume and volatility indicate a drying up of selling pressure.

Just look at the recent economic news and you'll know wave 2 is here.

Today, consumer confidence unexpectedly declined and delinquencies on the least-risky mortgages more than doubled. I'm staring at 'unexpectedly' right now. First we see a huge 30% rally propelled by better than expected earnings. 'Better than expected' ... or better yet, "Unexpectedly better than expected": analyst were so pessimistic about corporate profits/performance that their expectations were a lot lower than normal. Earnings kept beating expectations and the market continued to rally. Seeing that, consumers felt more confident. Even economic reports started releasing positive news indicating improving fundamentals. Everything happened as if we didn't go through the worst recession since the Great Depression.

All this is characteristic of the first wave when people believe that the worst is behind us. In reality, the worst is actually behind us but all is not over. Wave 2 is when fear creeps in again. Its a good shorting opportunity and also a time to prepare for wave 3. Write calls or covered calls. Writing calls in wave 2 season is far less risky. Even a person with a low risk tolerance can risk writing naked calls. But only after careful consideration. For more on this topic, refer to Writing Naked Calls using Warren Buffett's Philosophy.

Wave 3- one of the wonders of the long investor's world only if it is extended, which it usually is. I'm glad we're in wave 2. It'll give me some time to gear up for wave 3 and lock in some huge returns. BUY LEAPS!

Don't forget to visit my website at http://www.technicalanalysisbase.com/ and my other blog at http://technicalanalysisbase.blogspot.com/

Sanjeet Parab_____________________________