Volatility Cycles

Some of you eager beavers have to start wrapping your mind around the concept of markets moving in volatility cycles. Just like it is a common observation in natural systems (i.e. water, sound, electromagnetic) imagine a sinusoid wave that oscillates in repeating cycles. A few days ago I wrote an indicator that visualizes the idea very nicely – I call it ATRIP as it’s a hacked version of average true range:

What is important to understand is that these cycles are a natural aspect of all basic market types – bull, bear, and even sideways. In sideways markets they allow us to scalp or swing trade – an apt definition of the activity obviously. In trending markets low volatility cycles allow us to assess the tape/configuration and get positioned when high probability odds arise. Obviously the cycles don’t come and go like clockwork but there are ways to leverage them. For instance we are currently in a high cycle on the spoos and we are dropping. Once we start slowing down again it may be time to look for support zones but not before that.

The repeating cycles are prevalent across all market verticals, you will find them on the futures, on stock symbols, on Forex, bonds, everywhere. For some reason however I have rarely seen anyone address them in a constructive fashion (not saying nobody has but I have not found much) which is why I am spending some time on this. Once you grasp this concept you will never look at the market with the same eyes again. And it will probably affect your trading decisions as well – for the better!

Talking about possible support zones – on the E-Mini we’re looking at 1944 as the next possible bounce zone – assuming we actually drop much further that is. I’m not seeing a lot of mojo on the Zero today – at least not right now.

And if you add fair value then you get near the 1956 mark on the cash index – that’s where we find the 25-day SMA, which has been carrying prices higher before the recent correction.

EUR/USD – very interesting configuration here. This looks like a floor attempt and if we breach today’s highs I want to be long with a stop below today’s lows.

More goodies below the fold – please meet me in the lair:

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Good And Bad News For The Bears

Unless you trade out of a cave then you already know that the S&P’s 1600 ceiling was effectively smashed today. It’s doing the gap & camp near 1611 right now but the day ain’t over yet. Now if want to spend a lot of time regurgitating what already happened then I suggest you go look elsewhere. We stainless steel rats for one prefer to look forward as that’s where our edge is. So in that spirit let’s zoom out a little and take stock as to where we are:

Looking at our monthly panel what sticks out is that we may be in the process of painting a seventh month higher. Obviously May is still young but what we do know is that six consecutive months are already in the bag. Many intrepid bears have attempted to pick a top here and once more received a thrashing with the bad end of the stick:

Ouch – that’s what I call a perfect formula for a short squeeze. A lot of folks felt it in the groin area this morning and it’ll leave a mark for sure. So let’s talk about what all this means from a purely statistical perspective. I ran into some interesting numbers produced by Ryan Detrick who’s a CMT (cheeky monkey technician) over at Schaeffer’s. Basically in a nutshell:

  • Since 1972 six higher closes only have occurred 12 times.
  • Near term there’s a slight positive edge but obviously a medium term correction is probably on the horizon.
  • Long term there is a definite positive edge in being long, in particular six to 12 months later.
  • Incredibly after a six month rally the SPX is higher 11 out of 12 times a year later.

Read that last one again: That’s right – after the 12 occurrences since 1972 the SPX closed higher 11 times one year later. Now let’s look at another goodie I dug up just now:

That’s my long term P&F chart of the SPX. And today it triggered an ascending triple top breakout, which now bestows us with a new price objective of 1800. Yup, you read that right. Obviously we’re probably not going to make a b-line up to that and I expect quite a few gyrations in between. However, given the statistics there’s a decent change we may scrape it a year from now.

So if that’s the bad news for the bears – what’s the good news? Well, I don’t know how May will close but if it does close higher as well then the odds for a correction should be pretty decent:

Statistically speaking (again) a correction in June has pretty high odds, especially IF May closes in the green. So there you have it, of course we’ll monitor our charts all months and if I see signs of a reversal (e.g. distribution, divergences, stalling momentum, etc.) I’ll be sure to post it here.

Before I close shop for the week let’s catch up with a few more charts. Here’s the USD/JPY which is pushing into a daily NLBL, and that ought to put up a bit of resistance. However, the monthly is what I have been pointing at (also see my last weekend update) – it’s in the process of breaching its 100-month SMA and there’s nothing but air above. And if it drops it’ll enjoy weekly support near 96.125. This is one of those LT setups you don’t want to miss out on.

GBP/CHF – I was harping about that one earlier in the week and suggested that a drop into its 100-week SMA and that NLBL was a good buy. Well, it paid off as it’s recovering and if it clears that 25-week SMA then we should be good to go.

Let’s wrap things up with setup on the commodities side – sugar. Nice inside day candle plus it’s happening right below the 25-day SMA. Great inflection point and given all the commotion preceding it I think we may have a big move coming.

And that would be it for me today. We’ve had another fun week and it’s time to crack open a bottle of your most coveted brew. May I suggest a nice glass of Paulaner – in the U.S. you may be able to grab a few of those bad boys at Whole Foods for a bit over two bucks. Best money you’ll ever spend. I raise my glass to all you cheeky monkey technicians. Prost!! :-)

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Figure Pointing

The dreaded honeypot period continues and the bewildering gyrations of the past few weeks have not offered market participants any further hints as to where things may be heading next. That of course is the sole purpose of a honeypot formation, so let’s take a peek under the market’s hood and lay out some crucial inflection points.

Since early November the S&P 500 has been running nowhere fast. If you take away all the daily noise (something P&F charts happen to be very good at) then you see it priced near where it started out six weeks ago. In case you are not familiar with P&F notation – the little B on the chart stands for November and the C for December. The low pole reversal warning off the lows triggered over two weeks ago and if I would show you a snap shot of this chart back then it would look almost identical.

On paper things are looking more positive as the SPX managed to claw its way back above the 25-week SMA. But if you look at the past half year then one cannot help but wonder if this bull market is running out of fuel. And that despite almost daily Fed sponsored POMO auctions supplying cash to primary dealers.

Some of you old timers may recall a pertinent 2010 article over at tradingtheodds which strongly suggested that nine or more permanent open market operations in one month [historically had remarkable and statistically significant positive implications with respect to the market’s short- (e.g. at least one higher close over the course of the then following 10 sessions) and intermediate term performance looking 1, 2 and 3 month ahead (trading higher 3 month later on all of those 144 potential occurrences/trades).]

Although there is plenty of fuel to boost equities through an almost ritualistic EOY Santa Rally we seem to be stuck right at the gate of an inverse H&S pattern that ought to push us right into new highs. But in order to get there equities will have to bridge a volume hole that has been acting as a brick wall for over two months now. Regarding the H&S I must point out that the left shoulder still looks a bit under developed, so even if we breach that neckline (i.e. volume hole) next week there’s a good chance we’ll see another retest and possibly a bear trap before things proceed higher.

Seasonal odds however strongly support an EOY rally scenario, in particular as we are now pushing into week 50, which is usually when the proverbial rubber meets the road. Of course the odds are only the odds and as such do not account for the occasional statistic outlier that may throw equities across the board in a tail spin. Thus a failure next week or the following may have catastrophic implications and may lead to an early start into what I expect to be a game changer in 2013. To be clear – medium term the odds favor the bulls, but starting early 2013 I am seeing trouble brewing on the equities horizon.

For cracks are clearly visible across the board. The least shining example of which is AAPL, the rising star of the S&P 500 representing over 4% of its entire valuation (and if I recall correctly over 12% of the NQ-100). But it may soon turn out to be a falling star as the past two months have been less than kind to its valuation. Our P&F shows us a rather frightening bearish price objective of 445. There briefly was hope as it registered a low pole flag reversal warning on December 7th. However it since has dropped back near its recent lows and closed at 533.25 last Friday.

The long term panels are not looking any very positive either. The November lows near 505 were followed by a run up to its weekly NLBL which where things fell apart rather quickly. The monthly shows us far below a NLSL, which if not remedied by the end of this year will trigger a monthly sell alert, which in turn may lead us much lower than the bearish price objective proposed by the point & figure chart.

So if you would like to know where equities are heading in 2013 – and I’m sure you do – then I suggest you look at AAPL as that now has become our proverbial canary in the coal mine.

Let’s wrap up equities with the VIX which is now apparently coiling up between two diagonal trend lines. Seasonal odds support us touching the 15 mark, although it’s not impossible we may once again push a bit below if we see an EOY short squeeze. This would by far be my favorite scenario as selling complacency (i.e. buying vega) during a blow off top is one of my favorite past times. A breach of 17 may mark the moment where the wheels finally come off the equities wagon, but even in this scenario the possibility a VIX buy signal (relative to equities) would be likely rather quickly as the upper BB is now descending into the 18 range. The message here is clear – even if you have bearish dispositions, don’t be in a rush. Let the tape lead the way.

The Yen, here represented by the FXY, seems to be sitting at the gates of hades. Despite a relentless sell off the P&F is still pointing to a bearish price objective of 114.3. A drop below 118.5 would probably lead us there, so keep an eye on that this week.

Here’s the USD/JPY as that one charts better than the FXY on my long term interval charts. The weekly up trend here (remember it runs inverse) seems well established and there’s very little in the way. A monthly NLBL that may have offered resistance was conveniently averted and starting Monday only the upper 25-month BB may pose a bit of trouble. After years of relentless selling the USD/JPY appears to have produced a reasonably well tested floor and may now be ready for a nasty short squeeze. Definitely worth keeping an eye on this in the coming weeks and months.

On the EUR side I tried to make a point by drawing a square around the last three months of activity. Which pretty much tells the story – the Euro has been stuck in the bullpen since late fall and given the bearish price objective of 121 it’s possible we’ll see a break down below the 125 inflection point early next year.

Here’s the EUR/USD which thus far has lost its battle with a weekly NLBL. Even if it manages to to breach higher there’s still the matter of the two entangled monthly SMAs which will pose significant resistance. Perhaps there is hope for my Dollar exchange rate just yet.

Crude produced a bonafide P&F bull trap late last month and it’s now at danger of wiping out that bullish price objective near the 100 mark. A drop below 85 would switch us back to the bearish PO which was near 77 if memory serves me right.

I would love to tell you that this may turn into a profitable trade either way but unfortunately things are a bit more complicated. I see some strong resistance on the weekly side but there’s even strong support on the monthly panel. Perhaps selling condors may be the way to go? ;-)

Metals – gold has been rather lackluster as of late and the bearish PO of 1560 remains to be on the table. As you can see a drop through 1680 may lead to further ugliness for our intrepid gold bugs.

The weekly has been sporting awesome resistance in the form of a weekly NLBL – thus far it’s proven to be impenetrable  And most conveniently the 25-week SMA appears to be lining up with the inflection point I suggested on the P&F chart. So let’s keep an eye on that, shall we?

Silver, most definitely being the stronger of the two, has managed to weaken its bearish PO via a low pole reversal warning. This means the bears are on notice but not yet out of the woods (pun intended). What’s disconcerting is that this LPR warning happened three weeks ago and nothing interesting has happened since.

The weekly is however looking positive as silver is trading above its 100-week SMA and also enjoys support via two opposing net-lines. The monthly is clinging to the 25-month SMA and it has successfully survived a battle with its monthly NLBL near 33.3. I’m a bit on the fence here right now and am anticipating some sort of resolution in the final weeks of this year.

While we are on the subject of gold vs. silver – here’s the ratio which in the past has been a pretty decent purveyor of what’s in store for equities. Most recently the ratio has been dropping and that may suggest medium to long term trouble is on the horizon. Admittedly we need a bit more data but nevertheless it’s going to be very interesting to see what happens on the silver front in the coming weeks. If silver loses traction and drops alongside gold then this may be another piece to our equities puzzle for 2013.

Let’s wrap things up with copper – now donning a preliminary bullish price objective, which flies in the face of potentially bad news on the equities front. A bearish PO was reversed in late November and a breach of 3.7 may lead copper (and perhaps equities) into a coveted Santa Rally. There used to be a time when copper was leading equities – unfortunately this correlation has weakened in recent years.

The weekly panel suggests we are similarly at an inflection point. I suggested to you last week to look out for a breach of the weekly NLBL and it seems to be in the process of accomplishing that. If we close above again this coming week then I see nothing in the way until about 3.5ish.

Bottom Line: We are awaiting resolution across various market verticals, which is typical for honeypot periods. Once things start unfolding on all fronts I expect acceleration so this week we should keep our long term charts on a short leash and monitor all inflection points presented above.


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