Wednesday, June 2, 2010

Chaos

We prefer to assign reason. Or blame. It is a coping mechanism. People are rational beings -- though even that can be argued -- but people want reasons. People want answers. And when things don't go the way people believe they should go, they want something or someone to blame.

Truth is, markets are chaotic. There is an old saying, which comes in various versions, that if a butterfly flaps its wings, it can cause a tornado half way around the world. While the butterfly does not "cause" the tornado in the true sense of generating the energy of the tornado, it does "cause" it in the sense that a flap of its wings is an essential link in the chain of conditions that result in a tornado, and without this flap, this particular tornado would not have existed. This is a simplified adaptation of Chaos Theory. Some in the media would have you believe that leveraged ETFs are the butterflies. Then again, if you think about it, the media could be the butterfly.

Traders hear over and over how ultras influence the close, whether it be higher or lower. Traders then decide that they, too, are going to "game" the system and get in front of a move. Seeing the market fall, they sell or short something they ordinarily would not have done had they not heard about the impact of the ultras. This single sale is just enough to tick down a stock that otherwise would not have ticked down. This tick triggers some stops, further pressuring the stock. Not only that, but it also causes a small tick down in an index. This tick down in the index triggers more stops, which, in turn, catch the attention of technical traders, as this latest tick triggered a shorting or selling opportunity. And this technical indicator is independent of the ultras. However, this technical indicator causes more selling and/or shorting. And then... well, you get the point. Pure chaos ensues.

The market rallied on the heels of energy and a hint at a strong jobs report this week. Energy was overdue for a bounce and did so in strong fashion today. The momentum is clearly in the natural gas camp, and this is an area to focus on should there be any pullbacks. Oil may continue to struggle, and rallies here are still better for reducing exposure until the landscape changes.

The S&P 500 finds itself battling resistance once again, but this time, it has some momentum on its side. Volume was still disappointing today, but that only matters to some. I expect we will see some follow-through from today, however, I don't think we are out of the volatility woods just yet.

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