What Refco means for this market

From the Betty Ford Put Clinic…

In the movie “The Shining” there is a scene where the little boy is wandering around growling “red-rum, red-rum, RED-RUM, RED-RUM!” Which of course was “murder” spelled backward. This scene has popped into my mind because I am seeing and hearing a lot of traders wandering around growling “REF-CO, REF-CO, REF-CO, REF-CO!”

It is easy to blame Refco (RFX | Quote | Chart | News | PowerRating) for everything, and the media always finds a scapegoat when the market is going down, but the fact of the matter is that this market had it coming anyway. How all of this plays out is anyone’s guess, but a significant amount of liquidity has been pulled away from the market.

Refco and its many subsidiaries had a lot of proprietary traders. They were a large and active presence in both the cash and futures in equities, fixed income, FX, commodities, you name it. Most of these people are now on the bench. Maybe it is temporary, maybe it is permanent, but the liquidity provided by these traders will be missing for a while, and less liquidity = higher volatility going forward.

Yesterday was a mixed bag. The semiconductor and biotech sectors led the Nasdaq 100 back above its 200-day MA:

NDX

While the S&P 500 and the DJI continued to flounder, they did put in the type of day that a candlestick chartist might find bullish:

SPX

DJI

I would like to emphasize the “temporary” part. Yes, the VIX is “overbought,” and there are a gazillion “oversold” signals happening, but this market is heavy, and until further notice, bounces will need to be sold. Next week will be a great litmus test. Conventional wisdom is that earnings will be great. I hope they are. What I will be watching closely is the market’s response. If we have great earnings, and we don’t rally, look out!

Joe Corona

Joe Corona is a 23-year veteran trader who makes his living trading options and other derivatives. Mr. Corona has been a floor trader on numerous exchanges including the CBOE, CBOT, and CME. Joe most recently spent 4 years as Head Trader for Market Wizard Tony Saliba at Salibaco, a proprietary trading firm. He has also been an options instructor for the International Trading Institute where he has trained hundreds of options and derivative traders for major institutional trading desks worldwide. Joe is the Director of the Asia Pacific region for CDLS Consulting, LLC which specializes in trading U.S., European, and Asian options and derivatives.