Preparing for a Pullback

 | Sep 19, 2011 | 12:00 PM EDT
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Since bouncing off its lows on Aug. 10, the S&P 500 has been trading back and forth in a very unattractive, albeit steadily ascending channel.

Last week's gain of 5.4% -- the S&P 500's best weekly performance since late June and only the second weekly gain in eight weeks -- means that it is now near the top of that range.

I've had some success in trading that ascending channel, though with the benefit of 20/20 hindsight, I can see that it's been low-hanging fruit. After all, the S&P 500 has trekked back and forth between 1120 and 1220 no fewer than seven times since the sharp selloff in August.

As I indicated in my column "Betting on a Short-Term Bounce," I went long ProShares Ultra S&P500 (SSO) on Wednesday, Sept. 7. I closed that position on Friday morning, Sept. 16, for a decent if unspectacular gain, having held it longer than I had originally intended.

Here's why I did so...

Options expiration week is the strongest week historically in September. With the month getting off to one of its weakest starts ever, it seemed a good idea to close any long positions at the end of the strongest week in what is often a lousy month.

But it was the fact that the S&P 500 ended higher on Friday that gave me greater pause.

Any time the S&P 500 also been up five straight days -- with the market going from 1154 to 1216 -- I always turn cautious. It's actually a rule of thumb I have had rolling around in my head from a swing-trading course I took many years ago. So I tried dig up some data to support this intuition...

Now, I couldn't find data about what happened to the S&P 500 after five straight days of gains. But I did manage to dig up some information on what happens when the S&P 500 managed to rise for four straight days, with a successively larger gain each day. That's where the market closed Thursday. Note that the streak of "successively larger gains each day" was broken on Friday, despite S&P 500s fifth straight rise.

The "four-day scenario" has happened six times. And the market corrected over the short term every single time. Six days later -- think where the market will close on this coming Friday, Sept. 23 -- the average loss was 1.1%.

Those are odds worth taking, in my book...

So I'll be looking to short the S&P 500 through the ProShares UltraShort S&P500 (SDS) this morning.

I expect to close this short-term position on Friday, unless the market breaks out above the 1230 level.

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