Fundamental Trading Diary

Fundamental analysis of the capital markets

Selling The Short Squeeze Rally

I have sold 1 September ER2 contract short after-hours at 683.3. I’m looking for a 2-3% dip in the next week or two.


Some of the main fundamental factors being priced into the market are:

  • Heavy discount on financials for future earnings
  • Discount from naked short selling

The financials are very badly hit, but I believe they have farther to go because the write-downs will continue unless the housing market stabalises. This does not seem likely for the moment. With Fannie Mae and Freddie Mac in need of a lot of new Fed cash, the mortgage market will not be in any shape to help the housing market rebound. Lending will continue to be tight.

There obviously was a discount on many stocks, particularly financial, applied through the naked short sale of stocks. Since the regulations clamping down on those were in effect on Tuesday, the financial and tech heavy (highest short interest), the NASDAQ has climbed 4.49%. I do not believe that the discount applied by the short sales effected the market much more than this, so I would expect the downward forces to regain control within a few percent of where we are at now.

This, combined with the fact that there are now likely a lot of unrealised losses left in nearly all markets as hope for a softer landing prevails, leads me to believe that we’re soon going to embark on another leg downward for the next few weeks.

Concurrently, I believe the USD will become cheaper against the Euro as Fed chairman Bernanke assured Congress that Freddie Mac and Fannie Mae will have enough cash to operate. This essentially means that they will generate the income necessary, and the Europeans don’t appear to be (yet) doing the same.


As a consequence, I have gone long $100,000 EUR/USD at 1.5831. The USD has been rallying as the Fed has been waging a media war with the Europeans, and it has had a positive effect on the USD. I suspect this will be short lived – at least until the Europeans start to show that they are suffering through the same problems with over-leverged banks.


July 18, 2008 - Posted by | Uncategorized

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