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The Best Way to Trade in a Rigged Market

By Jeff Clark
Tuesday, September 9, 2008

"The stock market is rigged."
Jim looked up from his cards at the poker table to gauge my reaction to what he just said. "Honestly," he continued, "it's nothing but a bunch of Wall Street insiders pushing prices back and forth for their own benefit. There's no way the small investor can win."
At our monthly poker game last Saturday night, Jim was feeling bitter. He had taken a big loss on some index call options Friday morning as the market opened lower on the heels of Thursday's 344-point decline.
But by midday, the market turned around. And after the close of trading Friday, the Treasury Department announced plans to bail out Fannie Mae and Freddie Mac. The S&P futures market bolted higher.
If Jim had held his position until the market opened on Monday, he probably would have made a small gain. But he sold on Friday morning and took a big loss into the weekend.
"It's a rigged market," Jim repeated.
"Of course it is," I said, surprising the folks at the table. "But it's your own stupid fault for taking the loss. After all, if you're in a rigged game – and you know you're in a rigged game – then it's best to bet on the side of the riggers."
Truthfully, I don't know if the stock market is rigged any more than I know of the existence of black helicopters, the Trilateral Commission, or a second shooter in the Kennedy assassination.
But I do know if you're going to bet horses, you should check the stables for disposable syringes and bet on the horse with the most needles in the haystack. If you're going to bet on boxing, you ought to talk with Don King's bookie. And if you are going to trade the stock market, you need to watch three specific indicators.
The first, of course, is the action in Merrill Lynch (MER) shares. MER is Wall Street's version of the canary in the coal mine. The action in MER is a terrific indicator of the strength or weakness of the short-term market direction. If MER is rallying while the market continues to sell off, then the odds favor a reversal to a market rally later in the day. If the market is rallying but MER is steadily clicking lower, then the stock market will likely head lower as well.
There is no better indicator for the immediate direction of the stock market than the action in the shares of Merrill Lynch. If Jim was watching MER shares on Friday, when they opened at the low of the day and then rallied over two points by the close of trading, he might have held his index options until Monday morning.
Second, the S&P 500 rarely moves more than 30 points away from its 20-day exponential moving average (EMA) line . The line acts as a magnet. And if the S&P rallies too far above the 20-day EMA, traders can bet on a correction. If the S&P is too far below the line, traders should bet on a rally.
As of last Thursday's close, the S&P 500 was 43 points below its 20-day EMA. Friday's opening decline only added to that extreme condition. If Jim was paying attention, he might have seen this extreme condition and decided to hold on to his calls a bit longer. Indeed, by Monday's opening, the S&P 500 was trading right back on the line.
Finally, one of my favorite indicators is the bullish percent index.
A bullish percent index (BPI) measures the percentage of stocks in any given sector trading with bullish "point and figure" chart patterns. Now, point and figure charting is a science all to itself. So we won't delve into that here.
Suffice it to say, whenever the bullish percent index for a sector drops below 20, it's oversold and due for a bit of a bounce. If the BPI rallies above 80, it's overbought and traders should be on the lookout for a correction.
Right now, only a few sectors have a bullish percent index below 20. So yesterday's opening rally may not have much farther to run.
But there are two sectors where the BPI has reached a historically low level. And it dropped farther yesterday. So I'm anxious to jump in.
I'll be issuing recommendations to S&A Short Report and Advanced Income subscribers later this week.
My friend Jim doesn't subscribe to either of my newsletters. So he'll have to wait until next month's poker game for any advice.
Best regards and good trading,
Jeff Clark

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Market Notes
World's largest retailer, Wal-Mart, hits eight-year high.
Mortgage giants Fannie Mae and Freddie Mac hit all-time lows on news of gov't takeover... both stocks sink below $1.
Silver down 40% from its 2008 high, gold down 20%... Barrick Gold and Silver Wheaton, the market's biggest producers of gold and silver, hit new lows.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%