XLF Trade Set-up & Update

On August 1st I closed a FAZ (3x short Financials) position, Closing FAZ Long ...

"This is just for now to lock in gains, I'll decide later if I'm going to add a long like FAS for a bounce."

It was already obvious at the time that we were going to be building a base of some sort and I didn't see the risk of holding FAZ any longer as being worth the potential reward, but I also didn't see a strong enough set-up to open a FAS (3x long financials) bounce position.  Again, I don't trade on probabilities as I knew the probabilities were for a bounce in XLF, but rather on high probability/low risk set ups.  The reason why? Even though I would (so far) have been correct in entering a FAS long on August 1st which would be up about +5.53%, the risk of that position suddenly failing as often happens at this stage of the market, is too high. It's not uncommon in a weak market to have some fundamental event that hasn't been discounted send the market gapping lower, erasing months of long gains in days, for instance, late July 2011...

On this weekly chart of a 3x long SPY (UPRO) it took about a week to wipe out all of 2011's gains, -21% and at B over 2 weeks almost an entire year of gains were taken out.

This is why I don't just trade probabilities, but look for high probability and low risk, FAS never gave us a good entry.

 Here's XLF now, the white arrow is August 1st when the FAZ long was closed to lock in gains, as mentioned I had considered entering a FAS long for a bounce-piggy back ride, but there were never strong enough charts and a set-up to make that risk worthwhile so for the moment, I protected the FAZ gains and decided to wait for the next set up. 

The FAZ position was entered as a partial position because the resistance area in XLF was so clear, it seemed an obvious target for a head fake run, but it broke to the downside first. This could very well be considered a "Crazy Ivan" shakeout in which the initial break of support hits stops and draws in new shorts, that supply of sellers/short sellers is easy to accumulate which is what happened at the base area that formed just after closing FAZ (white trendline).

One of the reasons Crazy Ivan trades/head fakes are run are to create momentum without actually having to absorb all of the supply (invest a lot to create a bounce that you just want to sell in to). See my two articles, Understanding the Head Fake Move Parts 1 and 2 .

Essentially the new shorts provide the squeeze for a reversal to the upside. Once the range's resistance has been broken, new longs will enter XLF creating the second head fake or a bull trap. As prices start to fall back below former resistance, now support around the $23 level, the bull trap concept/head fake comes in to play, best described as, "From failed moves come fast moves", it's essentially the opposite of a short squeeze as longs have their stops hit which should be just under the range's resistance level and as price accelerates downward, shorts enter adding more supply and accelerating the sell-off. 

This is why I wanted to save some room in the FAZ position to add to it above the range which never happened. However, as soon as the base started forming, that area once again is in play and that's where I'd like to re-establish my new FAZ long (at the yellow arrow).

The long term daily 3C chart for XLF shows strong distribution through the range whereas this chart had confirmed price action prior to the range.

The 4 hour chart shows the same thing so the probabilities for XLF's longer term or primary trend are strongly to the downside, it's the high probability/low risk trade set-up I'm looking for now to re-establish the FAZ long.

Like the market averages, XLF has a 15 min positive divegrence and I doubt we get any major downturn until this chart deteriorates,  the longer term 4 hour and daily chart put the probabilities of this bounce failing very high, but I still want to enter at the lowest risk/highest reward.

Like the market overall and like the last two market bounce attempts and VERY unlike bounces before July 1st, there's has been immediate distribution on any hint of stronger prices so smart money with deep pockets are moving out of XLF/Financials even at these levels, but because their positions are so large ( a billion dollar position is considered average for many of the larger funds), they need time, rising prices/demand to exit these positions. Volume hasn't been stellar as of late so that only makes it harder and  the process takes longer, but in the end they should end up with an average exit somewhere between the bottom of the base and the top of the bounce or an average short entry. 

Our advantage is we don't trade in that size so we can be much more nimble with our entries/exits.

This 2 min chart of XLF shows exactly what I have been talking about, as soon as the base was done, the first hint of higher prices saw distribution rather than confirmation as it use to be the case until prices were higher, then distribution would start so there's a definitive change in character now that we have seen 3 times, essentially smart money is moving out at a faster pace which is evident by looking at breadth charts alone, you don't even need 3C to see more stocks trading below their 40-day moving average than almost any other time over the past 5 years.

The concept of migration of a 3C divergence, meaning to move to longer time frames, shows us that the distribution is getting stronger so we should have a good XLF/FAZ set up above XLF $23 if the market can hold out that long which I suspect it can judging by the 10-15 min charts and the size of the base.

XLF is one of several assets I want to have a short presence in so I'm setting price alerts from here to >$23 and will be looking for the next FAZ long entry. I'd prefer to have made some extra money on the bounce, but without the charts to back up the trade, I'm not risking capital in a sub-par trade, I'll just be patient and wait for the stronger trade to set up. At least the XLF short entry I waited for for several months finally looks probable.