Happy New Year!

Okay, as we’re getting close to kissing 2010 a last goodbye it’s time for ole’ Mole to start switching back into productivity mode. The only new year resolution on my mind is for us stainless steel rats to continue banking coin and to avoid the plethora of traps that are being thrown at us on a daily basis. The past two years have forced me to up my game quite a bit and as such I actually in some ways consider the nastiness we had to endure a positive experience. Of course the biggest change for me was the realization that the long term window is way to elusive to be factored into a reliable trading approach these days – thus I have narrowed my trading window to from originally weeks/months to now days/weeks. Far from being a mere instinctual decision this new short term approach has been heavily influenced by several factors:

  • My shift from a mainly EWT based approach toward development of a more sophisticated set of momentum and sentiment indicators.
  • A profound change in the inherent nature of the equity markets, e.g.:
    • extreme conditions persisting for much longer
    • retracements becoming more flat
    • increase in volatility (price/sentiment)
    • volatility extremes occurring within shorter time frames
  • A a shift in participant demographics (i.e. an explosion in HFT traffic, the exodus of retail traders, a smaller group of more Fed assisted TBTF primary dealers, etc.)
  • Increasing evidence of how POMO auctions can and have affected equities inflows and outflows; and an marked increase in the frequency of POMO auctions (i.e. QE and now QE2).
  • The realization that given these conditions a daily/weekly trading window increases the odds and also insulates a trader from being led astray by sentiment extremes or blatant Fed manipulations.

Looking at the above list one wonders what approach actually works reliably in such challenging market conditions. Long term success in trading was was never easy to begin with and thus was limited to a very small minority of players who were either connected or able to detach themselves from being anchored into a particular way of thinking (i.e. bullish vs. bearish). As such the turbulence experienced in the past two years led many once successful traders to the sidelines – either by choice or by sheer force via Darwin’s principle suggesting survival of the fittest.

I am now convinced more than ever that one of the few survivors of those rapid evolutionary changes in market conditions is the Zero indicator. While many indicators turned to mush in continuously overbought conditions, the Zero has kept us one step ahead. In the past few months I have often praised the daily Zero for keeping us on the right side of the term trend during inflection points that were often interpreted by the usual pundits as being opportunities for taking contrarian positions. However, all the while the hourly and in particular the Zero Lite (ZL) has been kicking ass and taking numbers. I’m posting a simple screen grab of this week’s rather boring tape to elaborate on my thoughts:

I am sure many of you have heard the expression referring the combination of certain things being larger than the sum of their parts. To that end I am quite certain that adding the commonly used VWAP to the ZL chart is a textbook example of just that line of thought. Alright, let’s get a bit technical: Quite simply – having watched the spoos bounce within the VWAP bubble for years now (i.e. VWAP in white as center inside a 2.0 standard deviation bubble) the game has traditionally been in guessing or predicting whether or not prices will either push above or below the VWAP line and of course if a push to the outter StDev bubble was a possibility. Finally, if prices were approaching the StdDev bubble on either the up or down side whether or not a retrace was likely or if prices would cling to that level and perhaps even breach beyond. That’s in essence how one trades VWAP – other approaches may exist, I’m sure, but most traders I know play it according to that simple set of rules.

Now, if you look at the chart above it’s rather easy to correlate various prices moves within that VWAP bubble with the ZL signal. More precisely – the one consideration for a swing trader or scalper now becomes whether or not the ZL signal supports a particular price move in the context of its position in the VWAP bubble. Key considerations before taking a trade now are:

  • Is the ZL above or below signal? That’s our most basic consideration as the zero mark delineates between an up or down trend.
  • How long has the signal stayed above/below the zero mark? The longer the more sustained the current short term trend.
  • Is the signal weakening? Example of that are pushes higher in combination with a positive but diminishing positive ZL signal.
  • Is there a divergence between signal and price? This kind of ties into the prior point but is considered a more pronounced situation in which prices are for instance painting new daily highs while the signal is clearly dropping off and maybe even dropping below the zero mark.

I believe that the combination of VWAP and ZL signal makes for a very powerful trading framework in which various systems could be developed. In the past year I have mostly been following this approach manually just like the rest of you whenever I was able to actually stare at the ZL chart all day. But many of you have been clamoring for a more automated way to follow the Zero and I believe that the framework presented above warrants a more systematic approach. However, before I sit down and start slinging NinjaTrader code I would very much enjoy some input from my intrepid gang of stainless steel rats. Many of you have been faithful Zero subs for over a year now – so quite obviously this thing is giving you some kind of edge. How about you digest some of the above and then report back right here with propositions, examples, and perhaps even rules for coding into a system. And yes, posting of annotated Zero charts is fair game – knock yourself out ;-)

Oh yes, and before I forget:


Go crazy and have a blast within your legal limits – wherever you are. For fuck’s sake – for all we know we only live once, so let’s make 2011 a year to remember.

Yours unfaithfully,

Mole

Merry Christmas!

That’s right – I revel in being politically incorrect. It’s almost Christmas on my calendar and I enjoy responding to ‘Happy Holidays’ wishes with a Clint Eastwood sneer and a stubborn ‘Merry Christmas to you too!’. Anyway, after being pounded by a six day series of rainstorms the heavens suddenly opened up yesterday afternoon to bestow Los Angeles with a beautiful Christmas present:

Contrast that gorgeous view with the nasty weather Europe is having to put up with right now and you understand why I moved my Teutonic butt to California almost two decades ago. As much as I cherish the Christmas season – I can assure you that winters in Europe (as on the U.S. East Coast) are no laughing matter. You just can’t beat the weather down here in Southern California.

Now, just as a friendly reminder – this is my last post for the year as the tape is going to be very quiet until early January. Besides, while you guys are embarking on your ill deserved holiday vacations I’ll be slaving along in some secret Silicon Valley laboratory trying to put together some prototype demos ahead of CES. My next post will be on January 3rd – probably during the session or shortly thereafter.

Alright, since it’s Christmas and all I’ll make this a freebie for everyone. Just don’t tell anyone – after all I have a bad reputation to maintain.

The smoothed version of the daily Zero has breached that lower support line and is now clearly pointing down. A signal like this usually suggests that some kind of reversal is on the horizon, but if we’re objective here the signal has been in the negative for a while now. So, it’ll better happen when it’s supposed to happen – which is usually in the first two weeks of January. Let’s wait for that and then revisit this chart to see if it’s supportive.

You may remember my spiral calendar chart which I pull out of my head every once in a while. If you don’t know what this means then just use the search box on your right with the keyword ‘spiral calendar’.

Another reason why we may be heading into some type of correction are two major cycle intervals – one being a F21 (i.e. 3090 days) and the other one being an F17 (i.e. 1180 days) – shown on my SPY chart above. In terms of sheer seasonality and given the current bullish exuberance exhibited by the longs the overall market conditions do support a drop. Why a drop? Well, we have been melting up forever so a turn date for the longs would not make any sense. Of course we have seen cycle dates come and go before – granted, none of them was above F20 and as far as I understand it the longer term cycle dates do carry a bit more weight. So I’d give this one much higher odds than any of the dates I’ve shown here previously.

Alright – one more before I hit the eggnog. I’m sure many of you are familiar with the concept of average true range (ATR). If not do a google search or just believe me that it’s an important measure of volatility. And while we’ve seen volatility on the (un-smoothed) daily Zero increase it’s been dropping like a rock on the nominal side of things. When the longs get that complacent and everyone expects stocks to keep taking the express elevator up bad things usually happen. Case in point – take a peak at similar readings last January and then again in April. Of course what’s also apparent from these prior readings is how long things can stretch out. So, we may have to wait while equities paint a blow off top before we’ll see a meaningful drop. Given the onslaught of POMO auctions scheduled for the next few weeks I would not be surprised to see exuberance get completely out of hand.

Mmmh – actually that ATR observation got me thinking. How difficult would it be to slap an ATR on the daily Zero?

UPDATE: Well, I decided to get off the eggnog and hack together my first draft of the proposed ZeroATR:

Not so shabby – is it? I can probably fiddle with this a bit more but it looks pretty valuable to me. I’m going to slap it on the hourly and ZL as well and see what happens. Stay tuned on that end ;-)

Wishing all of my intrepid stainless steel rats a very merry Christmas and a happy new year!!

Alright, here’s your fucking Christmas card – no go away.

Cheers,

Mole

Santa Off The Launch Pad

This season Santa got a little help from an intrepid gang of gnomes over at 33 Liberty. No big surprises here for any of us naughty rats – after all the writing has been on the wall for weeks now.

Up, up, and awaaaay!! Oh wait – that’s Superman – never mind.

The VIX buy signals have been spot on as of late – it’s like taking candy from a baby. I for sure am on the extra naughty list this year. Ooops…

See, the bulls are doing this the right way. Whereas VIX painted a panic move to the upside in late November, thus pushing outside the 2.0 BB (and producing a buy signal) the bears are slowly riding this cart down hill. That’s how you do it and that’s how you keep momentum flowing.

Here’s a little charting lesson for you noobs. See single momentum indicators in most cases have little predictive value – the VIX buy signals on the 2.0 BB is the exception. My SPX BB cross over chart shows you what happens when medium and long term momentum start pointing in the same direction. We had a similar situation early this year and it seems like 2010 will yet again paint a year of deprivation for the bears.

What’s even worse here is that both BBs are now pushing up steeply and breaching them would take quite a poke to the upside. Momentum remains to flow to the upside and in such a situation it will have to run out of fuel on its own time. So even if we get a little reversal (inside both BBs) most likely the dip buyers stream in, we get a another push higher, perhaps a third, etc. until we finally paint a high – preferably outside those two. In terms of seasonality this would tie into my thesis (i.e. fancy word for mental masturbation) that we will close the year around the highs and don’t see a meaningful correction until early 2011.

Copper has been painting a teeny weeny divergence but in the context of the minimal participation right now I won’t read too much into it. What’s more important is that it is not painting a major divergence right now, despite the fact that ole’ bucky has been holding around the 80 mark right now.

Since I’m yapping about commodities let me throw in a chart I have never shown to my stainless steel rats. This is my sweet crude crack correlation chart (love the name). Basically you got light sweet crude in blue and the crack spread (please google it if you don’t know what that is) in black. The past two years don’t provide too much insight to the untrained eye but let’s just say that crude usually follows the crack spread, so if you see a divergence (i.e. in April/May) you can expect crude to snap back in whatever direction the crack spread is leading. As you can see the crack spread is on an overdose right now – no signs of a divergence here either.

My NYMO:BPNYA chart continues to point downward – again it’s usually early but if that divergence continues the bulls will probably see a quick shake out in January. IMNSHO this is just too juicy for market makers to pass up.

Best for last. This is my long term SPX vs. SPXA200R chart (the latter being the percent of stocks trading over their 200-day MA). As you can see in the past few years every meaningful top was accompanied by a distinct divergence. The last one took a lot longer to play out but it paid off if you took an entry in April.

Only problem here is that I don’t see us above 90 right now – plus we are probably months away from coming close to a divergence. So, that may also play into my prevailing doubts about a deep retracement in the near term future (e.g. of the P3 variety). Looking at this chart – and given the obvious accuracy in predicting major turning points – I just have a hard time imagining a deep drop into the abyss here.

Bottom Line:

I have to admit that the contrarian trader in me is quite puzzled. The record bullish readings in the ISEE and other sentiment indicators as of late would have you think that a drop is just around the corner. But then I look at all the charts above and it looks like we may drop and then power higher without any care. Which sucks big time for me as I just can’t justfiy going long here – not because we’re scraping 1250 on the SPX – I just don’t like the setup. So, I’ll probably just have to keep watching this bitch grind higher until I finally get my reversal and a decent entry.

Damn you fucking trend traders – that’s exactly the kind of tape you love, don’t you? ;-)

Cheers,

Mole




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