Short Term Volatility Extreme

Click on Chart to Enlarge

Based upon the hourly chart of the VIX, the current point appears to be a relative extreme in  the VIX relative to its larger trend.  If you purchased put options on the indexes after my post at the beginning of the week, then this would be a first scale out point to exit part of the position.  Now certainly there is possibility of further downside, maybe dramatically more, but for near term expirations or as part of  consistent scale out strategy this makes sense as an exit or partial exit point on put option.

McClellan Oscillator Still Diverging

The action over the last few days has been interesting.  On Monday the S&P 500 and NYSE hit new all time highs and yet the McClellan oscillator closed below 0 as the SPY formed a bearish engulfing pattern on a slight break above resistance.

There seem to be only 2 sensible scenario here:

1. The market is topping and will make a significant decline after the chopping such in the last weak handed buyers.
2. The market is going through a consolidation/rotation with an upward bias - basically a contracting triangle with an upward tilt.  This would logically imply a strong upwards post triangular thrust.

Real money sentiment is still running pretty complacent compared to the data set for the entire bull market since 2009.  I will update as we get an further significant action.

Pete

Complacency In Market Suggests Downside Skew Over Next 2 Months

Click on Chart to Enlarge

The chart above shows times since 7-1-2007 where my proprietary real money daily sentiment gauge was at a relatively extreme low level which correspond with Friday's level.  Notice that all of the data points occur in this bull market, and most towards the later stages.

In any case here the point is that in the current bull market, when the levels of real money fear has been this low, there has been a marked downside skew moving forward over the short to intermediate term.  In fact, over the next 2 weeks. the next month, and even over the next 2 months, the max downside was over twice as large as the max upside.

The only cluster that showed an immediate upside skew was really the May 2013 period right as stocks were breaking into a new all time high after a sideways consolidation.  That is similar in context to where the market is right now, so maybe that is significant.  But after that instance, price chopped slowly high for 2 months, and then sold off rapidly in 2 weeks back to the exact level of the beginning of the cluster of complacency readings.

Basically there are 8 relatively unique clusters within this selection of filtered data.  And only the May 2013 cluster ( 1 out of 8 ) was not a solid intermediate term exit point for stocks when looking out 2 months.

Also the average maximum gain of an at the money put was 4.5 times as great as the max gain of an at the money call.  These are with expirations exactly 2 months from the day of purchase.

The average maximum gain on the put was 150% if only buying at the first signal of a cluster and including the "loser".

Basically 3/4 of the instances increased over 100% max gain for the put.

So it seems that if the market dynamics are similar here to what they have been during this bull market, it would be a solid trade to buy the put here and set and 100% limit exit order.  Now I think that using my bottom spotting indicators the exit could be more fine tuned, but for simplicity it seems like the simple 100% profit target would be a strong positive expectation speculative play.

As an alternative, for the investor, a put option hedge could be placed here if holding a heavily long portfolio of stocks.

I am already positioned with a downside bias here and don't plan to add on this signal.  But it seems likely to me that the Nasdaq Composite will run up a couple percent and eclipse the 2000 high before a possible significant decline.  So that is another factor here to follow.  Watch for a top reversal candlestick or possible failed breakout on the Nasdaq at which point to initiate the hedge or put option.

Pete

Bought SKF @ 49.71

Based upon last night's analysis and the potential here for a continued move lower in stocks, and the relative weakness in financials I have taken a small position in SKF which is a 2x short financial sector ETF.

I have the stop at 47.65.  If price move above Friday's high in SKF, I will adjust the stop up to 48.68 to cut the risk in half.

I will track this trade management here on the blog for educational purposes.


Pete

Suspect Rally Today - Plunge Ahead?

Today the Nasdaq rallied rather sharply and the QQQ filled Friday's gap down.

The Dow 30 and SP 500 also made nice advances.  However, across the board volume was well lower than Friday, and even below the 50 day moving average on several indexes.

There are several signs that this move may be short lived.

• Today the McClellan oscillator closed below 0 despite a sharp rally.  I dont have stats on this, but will note that the July 2014, Sept 2014, and Dec 2014 tops all occurred with the ratio below 0.  While the price today is not a new all time high in the NYSE, Thursday was an all time high, and today's close is equal to the highest closing prices other than last Wednesday and Thursday.  Similar days would seem to be 3/2/15 and 9/5/14 which both were key sell points for the short term trader.

Click on Chart of McClellan Oscillator to Enlarge

• My Panic Indicator shows complacency on par with the recent short term tops on 2/25/15, 3/23/15, 4/13/15.  Yet price is below those highs, suggesting a potential cap at this level of the price range given the implied market psychology.  
• Select SPDR etf's show that industrials and utilities were the largest gainers, and banking and housing were among the weakest performers.  This seems like a defensive rally as opposed to a "healthy" risk-on rally.  

Click on Chart of SP 500 to Enlarge

The SP 500 is within the bounds of a contracting symmetrical triangle currently.  Triangles are often continuation patterns, suggesting a possible upside breakout.  However, a triangle is often the second to last move in a price pattern in a trending move, and can be the final pattern of a complex corrective pattern.  

Given that price is within the triangle and well above the mid point of the triangle, it seems sensible that price may come down and further test the midpoint of the triangle or even the lower boundary line -- even if the pattern holds up as a bullish continuation.

My feeling here is that price will likely decline back below Friday's low, and may be headed back towards the February lows.  So this is not really a trade strategy, but just an analysis that the current price level may be a very low risk short.  A stop loss of a new all time high basis the NYSE index would be appropriate from my perspective if shorting an index here.

Click on Chart on NYSE to Enlarge

Pete

Bearish Divergences Abounding in the Short Term

As of yesterday's close in the SPY and DIA there are many short term bearish divergences suggesting a pullback is close at hand.  Notably...

• Daily McClellan Oscillator
• Hourly NYSE TICK index
• Hourly MACD
• Hourly Money Flow Index
• Daily TRIN

This morning a gap down is indicated which would break the hourly chart uptrend lines of the recent bearish ABC pattern set-up I have highlighted.  Given the price logic and the divergences, this gap down may be a sign that the pattern is playing out as expected with a likely move back down to the March lows or lower.

Pete

Short Term, Hourly Chart Sell Signal QQQ and SPY

Click on Chart of QQQ to Enlarge

Today QQQ and SPY both gave hourly chart sell signals below the recent highs as suggested in the bearish trade set up post from a couple days ago.

So if you look at QQQ and were to short it at the current price with a stop a penny above Monday's high, there would be about 2.3:1 reward to risk if using the 3/26/15 low as a profit target to exit the short after entry.

For further confirmation a break of today/Tuesday's low would be further indication that a multi day sell off is in force.  Using the same stop but entering at Tuesday's low, would decrease the reward to risk to closer to 1.25:1.  Either way, I would estimate a short here to be a reasonable trade given the overall set-up and market context.  But understand that the profit target is not necessarily huge.  I do think there is reasonable chance of a sell off to near the February lows, but we will need to fine tune the exit as we see any decline unfold.  Stop movement and watching for the development of bullish divergence on a further decline would be the strategy to employ to lock in potential profits on a short and wait for the appropriate market feedback for exiting.

Pete

VIX Suggesting a Short Term Top Is Forming Here

Click on Chart of VIX to Enlarge

This chart is VIX hourly with standard bollinger bands as well as a longer term deviation band.  When the VIX approaches or touches the lower long term band and the bottom standard bollinger band moves below the bottom longer term band, the market is often near a short term high.  It shows that the volatility or "fear" in the market is relatively low and may be due for a price decline in stocks.

That is basically right where we are at right now in conjunction with a nice bearish trade set-up which was posted yesterday.  I have purchased SPY May 210 put options for 3.00 today.  There is not a lot of room to the upside before the trade set-up shown yesterday is failed.  And price has come into the resistance zone with further divergences today, suggesting that a short term top still may be forming today.

I am still holding the XLF puts purchased a few weeks ago.  I am awaiting a buy signal or panic extreme in my trading system in order to exit the near expiration puts (April and May).

If entering the SPY puts above my suggestion at this point is to place a limit order to sell the puts at 9.00.  That would put SPY back near the recent low end of the trading range and fill the gap up from 2/3/15.


Pete

QQQ Short Trade Set Up - Price Logic and Bearish Divergence

Click on Chart to Enlarge

The chart shown here is an hourly of QQQ which is the Nasdaq 100 ETF.  For those who have followed this blog for a while and understand some concepts related to price logic and divergences, this should be an interesting pattern to watch unfold.  There is an obvious bearish set up here to short or inverse the Nasdaq if an appropriate signal occurs beneath point 0.

So notice the the move from -1 to 0 was retraced in less time than it took to form.  That indicates a probable short term (at least) pattern completion and the beginning of a new downward pattern in the market of some degree.  Now it is clear that the price action upwards from point X has occurred more slowly and with clear corrective/overlapping swings, suggesting that the move up from point X is probably a correction against a still developing larger downward price trend.

Since the smallest "pattern" that can develop is a 3 wave move, and point X has not been breached, it would seem likely that the next move down is likely to move below point X.  The other possibility from a pattern perspective is that a sideways/triangular pattern is forming within the bounds of points 0 and X.  In that case price would not be expected to break point X.

Now the study below the chart is a money flow index which is basically an RSI of both price and volume combined.  So it tends to be a leading indicator more so that price only based studies like MACD or RSI, etc.  Currently the MFI is displaying a bearish divergence at today's new high for the recent rally from point X.  Now the MFI is not at an extreme level, so it is arguably to significant.  But the other reasonable interpretation is that the current up move is very weak and this is an imminent sign of topping and another directional downward thrust in price.

Analysis is easy.

Consistently making objective buys, stop adjustments, and sells is much more challenging.

So for the trader here this pattern creates a nice set up to short the market or make a stop adjustment on an open short position to above point C if a sell signal is generated below point 0.  Another speculative play here would be to buy put options on the indexes here.  An ATM put option with April 24 expiration would have a very reasonable 100%+ profit potential if prices decline to point X before expiration.

If you have questions or ideas on managing open trades here or entering new positions, comment and we can proceed with further analysis and planning.

Pete