Friday, May 26, 2017

Further Signs of Intermediate Term Topping and Probable Downside to Come For Stocks 5-25-17

Click on Table to Enlarge

Last week I showed stats from past instances where there was a 1.5% decline in SPY the day after a 52 week high.  And the average displayed a notable bearish skew for the next couple months, though about half of the instances rebounded back to near the highs after that initial big sell off day.

This rebound scenario is what we have seen in the current market.

I have run a couple scans over the last few days, and it still appears that similar past markets have had a notable bearish skew looking forward a few months,

The chart above shows the forward MAX gains and losses from a scan including bearish divergences in VIX, total put/call ratio, volume, MACD and stochastics on daily and weekly time frames.  So basically just an across the board price and real money sentiment bearish divergence.  And the bearish skew is notable for the first couple months.

Another scan criteria looked at unique instances when there was both daily and weekly bearish divergence in the MACD when the VIX closed below 11.  The results were similarly bearish.

There are good trading opportunities here based upon my method and the data at this point.
Based upon past SPY data, shorting here and setting a limit order to cover at 5.75% gain while also setting a 5.75% stop loss would provide a roughly 2.25% expected value over the next month.  The trade would be exited after 21 trading days if neither stop nor limit was filled.

Any where in the 4% to 6% paired limit and stop orders basis SPY would be very reasonable plays.  And 4% the ratio of the risk to the expected value is the lowest, and after that there may be higher expected values with wider orders, but the risk rises more than the expected value increase does.

I am electing to purchase SPXU here and use 12% limit and stop orders.  The simplest way to do this is with an OCO, one cancels the other, order where one order is a sell stop and the other order is a sell limit.  Then set a time reminder to exit on June 26th if neither order is filled already.

For the options side of things, a 130% limit gain order from the closing price yesterday on a 241 strike June expiration put option, would provide a very positive expected value with about a 66% win rate based on past similar instances and the calculation of my algorithm.  For this trade, there is no stop on the option.  It could expire worthless, but a limit gain GTC is set immediately after entry.


Thursday, May 18, 2017

1.5% Decline in SPY the Day After a 52 Week High - Bearish Implications for Coming Weeks

Click on Table to Enlarge

The above table shows instances in the history of SPY going back to 1995 where a 52 week high was followed the next day by a loss of greater than 1.5%, which is what we saw yesterday in SPY.  This filter also look for only times where there was MACD bearish divergence on the weekly chart at the 52 week high.

From the closing value of the day of the 52 week high, every single instance lost at least 4.8% over the next month of trading. 

Even taking out the filter of the bearish divergence on the weekly chart, the results were that 11 out of 12 previous instances declined at least 4.8% over the next month.

So this adds further weight to the outlook I posted earlier today based on the more subjective qualitative price pattern and a general view of conditions.

So given this back test, it is putting us on alert that stocks are likely to fall a few more percent in coming weeks.  And a few of the past instances led to sizable corrections of 10-20%

About half the past instances showed an approximate 1 week rally to back near the highs after the first 1-3 days of decline, before then selling off strongly again.

The other half of instances basically had no substantial bounce after the initial big down day.

If there are questions about how to make a trade with stops and limits here, comment.  But the idea is that after a little further decline over the next 1-2 days, stocks rebound for a few days, and that may be an ideal time to use an inverse ETF to try to capitalize on probable further sell off.


Stock Market Expectations 5-18-17

Yesterday saw an oversized sell off in stocks compared to the recent low volatility trading.  But as mentioned in the last post a couple days ago, there were indications that a high was to be expected and that stocks were ready to correct.

So the question now is really what the probable future course of action will be.

I have run some backtest scans comparing the current market position to the past trading history of SPY, and I would have to conclude that there is not a clear directional bias based on the past tests.

Obviously the sharp sell off yesterday has a short term bullish perspective when looked at on its own.  But some of the other recent comparisons I've made have shown consistent muted upside for a couple months after the recent really low volatility type readings we've had in the last couple weeks.

Click on Chart to Enlarge

This is an hourly chart of SPY.  And the pattern here, from my perspective would suggest that there is a downside bias through June, with a possible low forming in late June.  And that would fit with a typical correction in stocks.  Historically, a median correction in the SP500 is about 6 weeks and about 11%.  This is for corrections that last greater than 1 month from high to low.

So given that we are in the seasonal "sell" time frame, and the time and structure of the pattern here near the recent high, couple with the technical analysis of weekly time frame divergence on the recent poke to new highs, I will proceed with an outlook that the downside risk still is greater than the upside potential for the next few weeks.

Looking at the MACD in the hourly chart above, we can see that it is "oversold" but with no bullish divergence yet.  I would certainly expect that a divergence will form on this time frame before a nice rally could ensue.  So, it appears that price still have at least some work to do here to the downside before a multi day low could form.


Tuesday, May 9, 2017

SPY At Bearish Divergence and Probable Intermediate Topping Point - Gold and Bonds Probably Set to Advance 5-9-17

Click on Chart to Enlarge

I have not posted much the last few months as it was apparent since the last post in mid February that stocks were running pretty hot and were likely to cool a bit, but there was no weekly time frame bearish divergence on the MACD in the indexes and the time duration of the leg up was relatively short for a completed leg up and expected sizable correction.

However the current time frame is a different situation.  The leg up is now 6 months long, which is mature, and at 15% the gain in the SP500, while below historical averages for a completed leg up, is certainly substantial enough to be a completed/completing move.

Currently while the SP500 cash has barely poked above the winter high, the SPY etf is slightly below still as of today.  However since the cash did move to a new high, I am treating this current region as a new high.  And now the MACD on the weekly time frame is in a bearish divergence which is really a more clear warning sign that a correction is more likely to arrive soon.

The chart above shows an hourly chart of SPY and also shows a bearish divergence today.  the daily time frame does not yet have its own bearish divergence since the April low, but I still view the current area as a time that a high could be made.

Seasonally, there is the old sell in May and go away adage, which also is coming into play now after a classic strong November through April in typical season fashion.  So that is another reason here to view the upside as quite limited for the next few months.

In term of market correlation the bonds and gold have been selling off substantially during this last 3 week run up in stocks.  And the inverse correlation in recent weeks (and technical analysis to confirm) suggest that bonds and gold could make a rally for a few weeks.  That would suggest that stocks may begin selling off as of this week.

On a longer term basis, this is a mature bull market, and the 7th year is the classic topping year on a decennial cycle.  And so from an investment standpoint, it seems imperative to have a clear exit strategy or stop trailing technique in place for long trading.

I personally am keeping GDX and gold mining etfs on the radar because the seasonality in the past is for a late spring or early summer bottom.  And the correction in gold stocks looks mature, though could certainly make lower lows into June.

Monday, February 13, 2017

Expectations Tipping To Short Term Sell Off - A Day Trade Perspective 2-13-17

Currently stocks have been rising on low volatility and hitting new 52 new highs for a few sessions in a row.  This post will look at a set-up which is occurring today that can be used as a day trade, but also gives further clarification as to what may occur during this week.

I made a scan this morning looking at the past performance of the following set-up:

  • new 52 week high
  • yesterday gapped up and closed positive on the day
  • today's price opened outside of the upper bollinger band
  • today gaps up more than 0.2%
So the idea here is a market that has been strong and hits a new 52 week high on a modest (or larger) gap up.

The short of it is than the intraday downside risk was about 4 times as big as the upside potential after the open (which would be today in our example).  And the average open to close change was -0.6% roughly, with data going back to Sept 1995 in SPY.

So plugging this into a trading strategy it is pretty simple to see that shorting or inversing at the open had a positive expectation in the past.  My method for the trade involves looking at not just the open to close change, but also the drawdown and run up during the open time of the trade.  In this case the expectation was increased by setting a profit limit order of 1.75% to 2.5% gain.

Also the average forward returns were negative on a closing basis for the 3 days beginning with the trigger day/today.  10 out of 16 instances showed 1% or greater max losses over the next 5 days after the CLOSE of the trigger day/today.

So from today's opening value it appears that the downside risk is predominant throughout the remainder of the week.

As a side note, with stocks gapping up today and moving up a bit in the morning after the open, the VIX has not followed its normal pattern of declining.  In fact it was up nearly 5% in the opening hour of trade today.  I have showed in the past that when the VIX pops higher, while the SPY also rises, the forward returns have been skewed to the negative in past instances.  

The skew in MAX loss to MAX gain has been about 2:1 over the following 2 weeks after a signal like this.  Currently the day hasn't closed, so I am not saying the study is active, but it has that look to it so far.  

But a simple and profitable trade strategy in the past would have been to enter short/inverse and set a limit profit order basis the SPY etf of 1.25% gain and a stop loss of 1.25% loss.  Then exit at the end of the time period in question if the trade had not filled an exit already.  The maximum profit on a closing basis would have been at 8 days forward of the signal day, or next Thursday's close.

Now the stats on these etf trade are such that a large amount of leverage could be used correctly based on performance stats, so a 3x inverse etf or a deep in the money option are other possibilities to take advantage of the set-up here.

I know this is looking at short times frames and low volatility moves, but the example shows how profits can be potentially made with consistency when the time is right.  We will see what happens.


Thursday, February 9, 2017

Put Option Trade Opportunity in SPY, 2-9-17

Click on Table to Enlarge

Currently with today's action I have run some scans and there is a significant opportunity here, though with a smaller sample size on the past instances.

The scan criteria was:

  • SPY at 52 week high
  • VIX closes less than 15
  • VIX closes down 5% or more on the day
Only 11 instances show up, but the skews over the next couple weeks are negative and provide profit opportunities.  8 out of the 11 past instances showed gains of 80% or more over the next 5 trading days, when buying an ATM option with 5 trading days until expiration.  This is based on the model I have programmed, NOT on actual past contract data.  But the model is probably slightly conservative on average in the theoretical returns calculated, because almost the entire time value of the option is stripped out of the result.

So a simple trade opportunity here on the options would be a SPY 231 put option with a Feb 17th expiration.  Limit order for entry 1.00.  Exit limit order 1.80 after entry.

All 11 instances in the back test traded higher the next day relative to the closing value.  So expect there to be at least a very small drop in the option value tomorrow relative to today's close.

Another point of note here, even a couple instances on the list where the decline was only about 0.5%, showed a 80% gain in the option value.  So the implication is that with the VIX this low, even a small drop could pop the VIX a few points.  And by the numbers on it, SPY would have to decline less than 0.5% to reach the break even point.  7 out of the 11 past instances declined over 1% which would be ~100% gain or more on the option.

The ETF side of trading also shows a profit opportunity but the volatility being so low, the absolute return expected is rather marginal over the short term.  Looking out 2 months though, given that the downside risk is anticipated to be greater than upside potential, a conservative play here would be the inverse ETF play.

Basically, setting a 3.25% limit gain on a SPY short along with a 3.25% stop loss on it, and exiting at 2 months from the open of the trade if not already exited by the limit orders, would produce about a 1% expected value on SPY.  Using a 3x leveraged ETF may increase the expected value by around 3 times, but the stop and limit orders would have to be adjusted by 3x% as well.

But let's say the market does falter 3% in the coming couple months, the 3x ETF could rise 9-10% while the market turns negative.  That would be a very nice swing in an account versus just holding.

Let me know if any other info is desired here.


Put/Call Ratio Analysis Helps to Identify Stock Price Tops and Bottoms

Click on Chart to Enlarge

The chart above is a slightly different version of one I have shown many times over the past several years.  This chart is a 7 day average of the total put/call ratio with some standard deviation bands around it.

The interpretation of the chart is pretty standard for technical analysis.  I like following this data because it is not looking at price.  It looks at a measure of underlying "sentiment" as evidenced by large scale options transactions.  So price is an effect of other underlying causes in the crowd.

I have made a mental construct over the years which likens the movement of market prices to physical movement.  Once a direction is set, there is an inertia, and other than UFOs, we typically see a process of slowing or momentum changing prior to a shift in direction of the object.

That "slowing" before a change of direction is evidenced by divergences.  So we have a situation where the direction of the market in this case is still "up", but the put call ratio is showing a marked divergence indicating that the underlying sentiment or driver of prices higher is actually slowing down.

As noted on the chart with red and green lines, the general idea here is to look for an extreme data reading, outside the bollinger bands indicating that the trend may not be sustained at that rate.  These extreme points are typically NOT final highs or lows.  The actual end of a move, will most often occur after a divergence develops, with new price extremes, but often markedly non-confirming put/call ratio readings.  And the reading at the end of the move are usually well within the deviation bands, and so do not appear significant on their own.

My point here is to give a little perspective but to make note of the classic divergence pattern here in the sentiment which has put me on alert that we are near the end of this rally since November.  And we are likely to see at least a minor correction occur of the uptrend.  It has been ~2 months since the extreme reading in the put/call ratio occurred.  And my observation of this types of divergences is that a trend often persists for several weeks after the extreme before a final price high or low.  If I had to make a guestimate of the average, it would be about 6 weeks.  So here we are at about 8 weeks since the extreme, and I believe that markets are likely to peak any day now.