Doh! So how many of you got stopped out of positions last week only to see the new week open with equities on a Viagra-fuelled rally? Yep, my hand’s up in the air, it wasn’t my greatest moment.

In the space of a week, we’ve had record falls in equity markets, prompting record amounts of government help, leading to record rises in equity markets. And this Tuesday, after all the bailout plans, we saw a 700-point swing in the Dow. Phew! So where do we go from here?

Last Week
Last Friday saw a climatic finish to a week of record falls in equity markets around the world. The main markets fell by 21% to 25% over the week, with some of the biggest falls happening early on Friday morning.

As markets plummeted, politicians uttered the same phrase in different languages, “We’ll do whatever it takes….”. But with little evidence of much ‘doing’, share prices continued to fall.

The media blamed the fall on a realisation that the economy was slowing. But back on earth, where we’d known this for months, markets were suffering from a combination of events:

• Hedge funds had to raise money to fund massive withdrawal requests from investors.
• All sorts of monkey business was going on in the credit default swaps market. There was plenty of speculation on the can of worms that AIG was holding, but the timing suggested Friday’s auction of credit default swaps on Lehman’s bonds was the main culprit.
• Until recently Iceland was famous for regularly providing The World’s Strongest Man and for owning West Ham United. Even the prospect of it going bust didn’t seem that important until the discovery that over 100 UK councils had collectively parked over £1 billion in their frozen savings accounts. Not only that, but several of the Icelandic banks had been key players in the private debt and leveraged loan markets, and were now calling back their money.

This selling was never likely to have been halted by co-ordinated half-percent rate cuts.

Eventually Governments Got Their Act together
The UK’s man at the top, Gordon Brown knew just how serious the situation was. His own job was in jeopardy, but here was a chance to rescue the situation by showing decisive leadership. He persuaded other countries of the merits of the UK bailout including, crucially taking stakes in troubled banks and guaranteeing lending in the Interbank market. The EU followed with its own bailout and the US brought up the rear a day later.

Did it work?
Bath will have won the Heineken Cup before we really know whether it worked, but it was a good stab at solving the most immediate problem, a global meltdown.

Crucially, the most immediate confidence indicators, the equity markets gave a whopping ‘thumbs up’ with the Dow rising just short of 1000 points! The VIX fear index fell from a record 76 on Friday to 57 and US 3-month money rates dropped from 4.82% to 4.64%.

But these moves were more related to confidence (or relief). More concrete proof will take longer; there’s been little improvement in longer period money rates in the UK despite the government guarantee; Sterling 3-month money rates remain at 6.25% compared to official rates of 4.5%. But those in the know say this is down to the lawyers reading the small print and drawing up new contracts (the legal profession is one of the few recession-proof jobs).

And it’ll take months to see if the new government sponsored banks will really play Santa Claus with our money.

What Else Should We Worry About?
There’re two bits to this, market related worries and economic worries. The economics are a necessary background. But for us traders, it’s the market-related worries that determine whether we eat steak and chips or tinned dog food.

1) Market Worries
For me, the most pressing question is, ”Is there any more of last week’s action left?” It’s safe to assume that the Lehmans Credit Default Swap auction is done and dusted, but there’s likely to be a whole IKEA store of Credit Default Swap skeletons still rattling around in cupboards. We’re talking about a $516 trillion derivatives market here. With a number of players now either bust, part rescued, or under new ownership, there must be a whole Pandora’s Box of claims and counter claims that the banks are trying to keep a lid on. This morning the head of the UK’s Treasury Select Committee called for greater detail of the banks’ exposure to derivatives, saying that the £37 billion cash injection may not be enough.

Hedge fund redemptions. A lot of hedge funds imposed an end of September deadline for clients wanting their money back in December. The question is whether the selling to fund these withdrawals was completed last week or whether some hedgies held back, waiting to sell into any rally.

Margin calls. When money’s tight, and markets are bouncing around like Jordan on a trampoline, investment banks restrict the amount of leeway they give their leveraged clients. They up the margin requirements and close positions if there isn’t adequate cover. As clients of paddypowertrader you might not be aware of this, but a lot of other spread betting firms have been upping their margin requirements over the past week.

2) Economic Worries
The housing market. Prices are still falling and need to fall a lot further to make them affordable. This isn’t just about government banks making money available; it’s about the multiple of earnings needed to buy anything more substantial than a tent from Millets. With unemployment increasing and bills rising, how big a property portfolio will the banks build up over the next couple of years? How much extra capital will they need to support it?

China. The original cunning plan was that China would continue to grow economically, thus cushioning the slowdown in the developed world. But the Chinese index has fallen 64% this year, and commodities have taken a real caning, on fears that lower demand for Chinese goods is far outweighing its domestic growth. Having said that, Chinese GDP is still around the 10% mark, so not quite in recession territory.

The part-nationalised banks. It’s early days, I know, but I’m nervous of the prospects for the new-style government-sponsored cash machines. Dividends are being halted in order to lend aggressively at 2007 levels and to support those in trouble with their mortgages; a sort of Karl Marx business model.

How Am I Trading The News?
With so much going on I’m focussing solely on trading the FTSE. I’m keeping an eye on all the main equity markets, gold, oil and the Dollar crosses, but I’m only using the FTSE dealing ticket.

So far it’s been right to sell each ‘government initiative rally’. And that was still the case on Tuesday, although the subsequent price action showed a lot of nervous traders. The Dow traded a staggering 700-point range, dropping from 9700 to 9000 before closing at just above 9300.

Last week’s very oversold market was due a sharp correction, but I don’t know if we saw the whole shooting match on Monday or whether Tuesday was a nervous correction in the early stages of a bigger rally.

At the moment I’ve been trading intra-day patterns, using a mixture of candlesticks, support and resistance lines and moving averages. But I start each day with a close look at the daily charts:

Check out the red candle with a long dangly bit; that’s a hammer and it’s a bullish reversal signal in a downtrend. What’s more, the following long green candle confirms the move. This is a ‘morning star’ bullish reversal pattern. Together this looked set to kick-start an ‘option expiry week’ rally, but yesterday’s close made a bit of a mess of that. I reckon today’s candle needs to try and hold yesterday’s lows to keep the pattern intact.

In downtrends prices struggle to get much above their 14 or 21-day moving averages (MAV). I reckon the FTSE is still in a downtrend. Now, the 14-day MAV is at 4580, give or take, and the 21-day MAV is close to 4750. The index is overdue a meeting with its 14-day MAV, although last week’s price movements mean that the average could be doing most of the work here. In other words, the averages might fall to meet the price rather than the other way round.

I feel happier trading FTSE to the short side, mainly because it’s with the trend and sentiment is still very nervous. However, although I’m not a fully paid up member of the technical analysis dark arts, I’m going to stay very awake to the possibility of a rally back up to 4600-4700.

This means that whilst the markets are so volatile I’m keeping my bet size small. There’s no point in using a tight stop loss in these volatile markets. But there’s also a risk that even a wide stop loss could be triggered so I’m not risking large amounts.

The key point is to keep my trading capital intact for less volatile times.