The Wheels Are Coming Off

It seems that the wheels are finally coming off this carefully managed market. I think we all know that the writing has been on the wall for a while now. In recent weeks the bulls managed to fumble several important inflection points and bounces near important lows have become weaker and more sporadic. That may be forgivable once or twice but at some point there will be a price to pay. We have a ton of material to go through today – I promised you a long term update and I’m actually glad I waited another day as we are at the cusp of a potential trend change – medium term most likely and perhaps even long term.

2014-10-02_weekly_stochastic

 

Let’s start with the easy (but reliable) stuff – our weekly stochastic on the SPX. I’m sure many of you use that indicator – but very few actually know what makes it tick. It’s rather simple – a stochastic follows the speed or the momentum of price. As a rule, the momentum changes direction before price. So it’s not so much about where the line is right now – it’s about how it correlates with price movements.

If you’ve been coming here for a few years now then you probably remember this chart and you probably also know that I rarely use neither a stochastic nor a MACD in my daily charts. I think they’re generally overhyped and almost always lag behind. On the weekly side however it’s been a great tool for confirming trend changes – it rarely fails.

The only times it did fail were actually earlier this year when the K% line touched the 50 mark twice (it’s an oscillator really not an indicator) and then bounced back higher. Very very rarely does this actually happen – in most cases we see more downside after that. Not always a touch of the 20 but always more significant downside. I am not going to resort to speculation or conspiracy theories here – that’s not my style. But that said – equities have had a lot of help in the past few years and these things are to be expected. They often however also point toward the formation of a medium term or even long term topping pattern.

Markets can not bubble higher forever – corrections are healthy and are needed. It is a fact of general market dynamic that many investors would like to ignore and often irrational exuberance can frustrate hardcore technical traders for longer they would care – or perhaps afford. We here at Evil Speculator may be hardcore but we have long learned that lesson and that has served us extremely well over the past few years. However, we must also not fall into the trap of recency bias – even on the long term side. So let’s consider what other evidence is on the table right now – and there happens to be plenty.

2014-10-02_SPXA50R_SPXA200R

So let’s move on to breadth – here’s the SPXA50 vs the SPXA200 – it shows us how many stocks in the SPX are trading above their 50-day SMA vs. the ones trading above their 200-day SMA. Basically you plot the 50 against the 200 in order to know when the 200 is falling behind. Some people have a problem understanding ratios but they are pretty simple if you think it through – on one hand – on the other they can also be complicated.

The 50 gets divided by the 200, right? So if the 50 is dropping and the 200 remains the same then then we know that stocks are still above their 200 but more are falling through their 50. For example if the 50 is at 1.0 and the 200 at 1.0 we get 1.0. Now what happens if the 50 drops to 0.8 and the 200 only to 0.9? Now we dropped to 0.89.

It’s not my intent to give you an algebra lesson, but my point is to start thinking of how momentum works. Because let’s say the 50 goes to 0.9 and the 200 remains at 1.0? That’s good isn’t it? More stocks above their 200 is a good thing, right? Well, not really – because now man of those sticks are approaching the 200 SMA. If you do the math the ratio comes out to 0.9, so technically we’re very close to where we were. Remember that the 200 is a lot slower than the 50 and initially the latter is easier to recover – as stocks draw lower however it becomes harder and harder.

The 50 is easier to recover after a quick fall – so sometimes you get a quick drop and a ton of stocks fall through their 50 SMA. The same stocks may be mostly still be above their 200 and after a few trading days they may manage to recover the 50. So all is good again, right? No – because we are now closer to the 200 on many fronts and the next time a good number of stocks drop again some of them will take out the 200 as well. So it’s a bit of a complex interplay between two moving averages. Just imagine in your mind the 50 gyrating above its 200 – both represent general smoothed price dynamic and the ratio between them tells us about the health of the market.

Another aspect of breadth our outliers – you may often have a core of outliers that keeps the indices at a certain mark – stocks like AAPL, AMZN, or most recently BABA. Their high valuations may distort the real story behind the remainder of this index’s underlying health and momentum – but breadth tells that story clearly.

2014-10-NYA50_NYA200

Here we play the same ratio game on the NYSE. I am having a harder time drawing any conclusions on this one but thing is clear: the dynamics of market behavior seems to be shifting. Just watch how the 2013 advance extended into early summer and then suddenly something broke. What we are now seeing could very easily be the beginning of a underlying shift in market dynamics. If your portfolio is still heavily leaning toward the long side (i.e. delta positive for option traders) then I suggest you start paying attention as to not outstay your welcome.

2014-10-02_NYDNV_NYUPV

Here we are looking at the NYSE declining vs advancing volume. Yes you guessed it – breadth again – same idea. But we are measuring NYSE volume this time and it tells us about the vehemence of the ongoing move, to the up- and downside. It’s been pretty contained in the past few years and even right now there’s no real sense of a panic. Complacency still rules the day.

2014-10-02_VIXV_VIX

On the VXV:VIX we measure 30-day vs. quarterly implied volatility. In essence this tells us how market makers feel about the next 30 to 90 days. It’s been a bit of a ping-pong game in recent years and the best I can tell you right now is that we are probably going to head down a bit further before we see a short term bounce.

2014-10-02_VIX_VXO

The VIX:VXO is more focused on the next few weeks and we also seem to have more downside momo available to us. So be very careful in picking lows here, you may be overwhelmed by unexpected market behavior which we have not seen in recent years. I’m not saying a bounce cannot happen here – I’m actually covering that further below. But don’t jump to conclusions and expect the same BTFD behavior as in recent years. Investors are clearly a bit rattled and it’s not business as usual as in recent years.

Alright more long term goodness below the fold – please step into my lair:


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Alright, all that ought to keep you guys busy for a while. Seems like it’s going to be a fun fourth quarter. Let’s get that money!

Cheers,

Mole’s Cunning Plan

Equities have been holding their ground overnight and it’s completely plausible that we may see an attempt to squeeze momentum higher early in today’s session. However, thus far the reversal has been anemic and the recent lack of buying mojo calls into question whether or not the bulls will be able to overcome the first major hurdles waiting ahead.

For one there’s the 25-day SMA (weak) near 1950 followed by a volume hole a few handles further near 1960. If you remember my ‘zoning low’ chart then you recall that this is where the bearish scenario rapidly loses its luster.

Since yesterday’s drive higher our SPX P&F chart has switched into bullish mode, as would be expected due to the double top break out I pointed at last week. Now this is the price potential given we hold here and perhaps even drive higher. But if we run into a wall then this would trap a hell of a lot of longs, wouldn’t it?

And that potential scenario has been in the minds of market makers as the VIX:VXO isn’t yet buying this rally. So short term near term option premiums seem to going at a slight premium.

On a quarterly basis however the market believes that it’s clear sailing ahead – kind of. A bit tepid that signal but let’s not try to read too much into it. One step at a time.

So what happens right here and now is rather important, wouldn’t you say? The GBP/JPY correlation meanwhile is pointing down and I intend to keep a close eye on that one during the open. Yesterday it’s been useless to us as Forex markets were digesting the BOE’s quarterly inflation report.

Now if you’re a sub then you may have taken our NQ long and thus far it’s banked 1R as of this writing. So we have to make a decision now – do we hold it in expectation of a run higher or do we take our R here and run for cover? I have decided on a hybrid approach – which means I will advance my stop to break/even and keep the NQ long. Meanwhile, as I’m expecting downside, I will balance myself delta neutral where I expect the most weakness. This way I can wait until I get a proper entry on the short side which will only happen if we see spoos run into a wall. So effectively I just bought myself a cheap pass to sit out some of the whipsaw we can expect up here – I agree with Scott that we are approaching an important inflection point.

And here’s what I suggest on the short side – please step into my lair:


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So that is it – Mole’s cunning plan – and no invasive surgery is required.  Now let’s see if we get away with it ;-)

Cheers,

Bear Pörn

I’m not feeling so great today and I hope the few of you who are not on vacation can forgive me if I make this one snappy. On the equities side not much has changed since the overnight ramp and from a trading perspective the current tape is rather uninteresting. I’m sure you’ve got better things to do and so do I. The futures and forex side look similarly lackluster – so instead I decided to indulge in a bit of bear pörn today. Which however comes with a disclaimer: Price continues to point upward and the LT bullish trend remains unchallenged – so take the following charts with a x-large helping of salt.

On a short term basis I’m seeing a healthy divergence on our GBP/JPY equities correlation chart. Thus far gravity remains suspended and the E-Mini has happily bubbled higher. If I was ST long I would probably take profits here in anticipation of a little shake out.

Long term I have been watching this divergence on the VIX:VXO ratio – as you can see front month ATM premiums have dropped quite a bit in comparison with the remainder of the front month option chain (thus pushing the ratio higher) and we are now seeing a little correction which started early this month. So far price has not responded and per prior examples it may be delayed. If this divergence continues I would get very cautious on a 1-week forward looking basis.

However a similar divergence is seen on the VXV:VIX which compares quarterly implied volatility with front month IV. That one should make anyone exposed to the long side a lot more nervous – and again if it keeps dropping then price will most likely respond eventually. However here I would expect a multi-week correction, once it happens.

A bit more subtle but supportive is the formation we find on the SPXA50 vs. the SPXA200. It seems breadth is diminishing after having reached a reversal zone near the 1.0 mark. Again price has ignored it this far and that’s not unusual given prior context. I wouldn’t worry too much here yet but keep an eye on this one. On its own it only has limited meaning but if the two prior charts remain in correlation over the next few weeks then we do have enough evidence to warrant caution on the long side. After all it has been while since we have seen a thorough medium term correction.

Bottom Line: If you are long then there’s nothing to worry about just yet – stick with price and trail your stops as your system dictates. We need to see more extreme measures until we would switch the bullish case into Defcon 3. But early signals are flashing and we ought to keep an eye on them. I leave you with this:

That’s right – no more Mr. Nice Bear!

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Cheers,





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