Short Squeeze Triggers Sharp Volatility in Stocks, Have We Reached a Near Term Bottom?

For the first time since March 2003, the Dow Jones Industrial Average broke 8000 at the open of the US markets. However just as quickly as stocks dropped 600 points, it recovered more than half of its losses in the first 15 minutes of trading and actually moved into positive territory 35 minutes into the trading session. The capitulation followed by the major short squeeze suggests that we may have seen a near term bottom. This type of volatility drove the VIX index to a record high of 70.

Currency Traders Waiting for the Buying Opportunity

Interestingly enough, we have not seen much of a reaction in the currency market. This suggests that the capitulation is only in stocks and traders are waiting for the bounce to get in. The day is early so many things can change and equities could sell off again, but for the time being, it appears that the buyers of EUR/USD, GBP/USD and USD/JPY are sitting on the sidelines waiting to get in. If stocks start bottoming out, carry trades could actually bounce today. No one will want to be short carry ahead of the G7 and G20 meeting this weekend – we expect a bounce.

Pessimism in Uncharted Territories

Pessimism in the market has hit uncharted territories with the TED spread reaching another record high. This indicates that liquidity remains a problem and unfortunately confidence in the markets is tied to liquidity. Lehman has a CDS auction today and the rumor in the markets is that governments could resort to temporarily shutting down equity trading. This seems nearly impossible by theory, but it is certainly becoming a growing possibility. There is nothing more coveted than cash right now and the continued hemorrhaging will force the G7 and G20 into action. It will be another long weekend for US Treasury Secretary Paulson and Federal Reserve Chairman Ben Bernanke. There is even talk that the US is considering a guarantee of bank debt.

About Kathy Lien 236 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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