Count On Volatility

I would like to expand a little on the topic of my Thursday post which submitted that 2015 will most likely be remembered as one nasty sideways high volatility wood chipper, inflicting massive losses on both bulls and bears alike. As we are gradually transitioning out of a QE fueled artificially engineered bull market fear and confusion are slowly replacing an abundance of greed and complacency (just look at the daily VIX before August). And that really should not be any surprise to anyone – it’s been a lot of fun and laughs over the past seven years but the end of the line is in sight and it’s now time to pay the piper. Please understand that I make this point without any ulterior motives or allusions of possessing any predictive powers.


All we have to do is to listen what the tape is telling us on a daily basis. There really isn’t much to it – assuming you somehow manage to quiet down the incessant cacophony of your own ego emitting a never ending stream of opinions and distractions. After all in this, the greatest game of our time, we are often our own worst enemy. But even the thickest mind should should have a hard time refuting that we are not in any trending phase right now and that in fact intra-day volatility has become the name of the game. It remains to be the one constant we can depend on these days. Whereas the direction of the (mostly bullish) trend and BTFD was the modus operandi over the past few years, catching the next sharp turn remains the only way to extract yourself a modicum of ill gotten gains. Thus as successful traders your primary concern should not be direction – it should be volatility.

Which appears to be expanding – and has been slowly all year. Not that the VIX would have offered you any indication whatsoever as to clear and present downside risk I was highlighting right here at Evil Speculator on a regular basis starting as early as late last year. Everyone out there was simply in a holding pattern, waiting for one last push higher – just like drug addicts begging for just one more hit before committing themselves to face cold turkey.


It’s been a while since we’ve experienced conditions such as these and the only other analogy in recent history is the big shake out in 2011. If you compare what happened then you’ll find the same pattern:

  1. Sideways topping pattern after a massive squeeze that lasted months.
  2. Fast drop to the downside.
  3. High volatility shake out period.
  4. Resolution.


Now if you look at the current year you see an almost identical pattern, however there are some crucial differences I would like to point out as well.

  1. Starting late last year we experienced a sideways topping pattern with increasing volatility. Again the VIX was ignoring it all, except during quick drops which served as buying opportunities. However things were already starting to slow down in 2014 – the buying frenzy that preceded 2015 was the result of a big correction which spiked the VIX all the way to 25.
  2. The fast drop played out just like it did in 2011 – even the magnitude of the correction is roughly the same.
  3. The current high volatility directional guessing game is per the same script and what will follow late this year or early next year is the final resolution.

Of course the direction that the fourth phase is going to take us is the topic in everyone’s mind, and as always (un)educated predictions are as ubiquitous as lofty theories as to what the Fed or the ECB may do or say next. But before you go and throw your own 2 cents into the big smoldering stew of opinions ask yourself this: How accurate have your own predictions and assumptions been in the past few months or in the past few years? Were you the one who traded the SPX all the way from 667 to 2100? If so then please go ahead and bet the house. I for one will continue doing what I have been doing pretty effectively since I started to see the light sometime in early 2010 – simply follow the tape and leave academic theories to the professionals. After all – I just work here and the day you start taking things personal or seriously is the day when you should call it quits.

Never take advice from anyone in a tie. They’ll bankrupt you. Don’t ask a general for advice on war, and don’t ask a broker for advice on money. — Nassim Nicholas Taleb

The future is now – so don’t bring a knife to a raygun fight. If you are interested in becoming a Zero subscriber then don’t waste time and sign up here. A Zero subscription comes with full access to all Gold posts, so you actually get double the bang for your buck.


The Reckoning

For months now we have been watching equities flail around sideways, plotting increasingly spasmodic gyrations which have tested the patience of even the most battle hardened veterans. The recent series of gaps and overnight price jumps have only added to our growing list of evidence suggesting that we are witnessing an increasingly unhinged market. Adjusting to and surviving unscathed in such market conditions has been no easy task but I can truly say that we have negotiated some of the most challenging tape in years like bosses.


But now the time of reckoning approaches and I want you all to take a deep breath, lean back, and detach yourself from daily chaos that has thrown your feeble minds into recurring tailspins. We are going to look at some weekly charts because it is there where some real magic is going to happen in the coming days. Let’s start with the S&P E-Mini futures.

First thing that stands out is that we haven’t really gone anywhere since late last year. I’ve covered that topic to exhaustion and will not waste our time on regurgitating this again. Volatility has been out of control and the current VIX reading of 13.37 is a big joke. One I plan to exploit to the max however. Look at that stack of weekly Net-Line Buy Levels which starts at ES 2113 and ends at ES 2122 – we also have one at ES 2118.

This is where the boys are going to separate from the men. Meaning – if we get anywhere near that I plan to accumulate a nice collection of front month lottery tickets (a.k.a. OTM puts). They are not going to cost me much and I will expect to lose all the premium. However at the off chance that the bulls drop the ball there – which I estimate at around 20% – 30% – they are going to print ‘una burrada de dinero’ as they say over here in Spain.


So yes, we are talking lottery tickets. Here’s the same view on the YM – the range between the Net-Lines on that one is actually a bit more narrow starting at 18089 into 18180 – barely 100 YM handles.


Finally the NQ – here we are almost there which is why it probably should be our canary in the coal-mine.

I promise you it will take days for you to get that song out of your head again 😉

But seriously – watch the NQ and note what it does as it’s starting to bump into those Net-Lines starting at NQ 4536. If it happily pushes higher then we should hold off and perhaps wait for new instructions. If it stumbles and encounters resistance then we may have a shot at exploiting what I would consider the fattest chance for the bears in a long long time.


ZN Update – it’s looking good so far and I’ve moved my stop to break/even. And so should you! I’m holding this for a potential run higher on the daily – which makes this a daily campaign now.


Same idea on the AUD/NZD – another good entry yesterday and thus far it’s playing ball. First hurdle ahead will be 1.2 – if it pushes above it we may be able to enjoy another short squeeze.

A few more goodies for my intrepid subs below the fold:

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A bit of event risk today – try to be out of CAD related pairs after the NYSE open. We also nave some Kiwi tremors after the close.

Now have fun but keep it frosty.


Abnormal Tape

One of the strengths of human nature is its ability to quickly adapt to changing environmental conditions. At its core this is the primary reason why human beings, a physically rather underwhelming species, managed to achieve dominion of all reaches of the planet we inhabit. Whether or not that is a good thing I leave open to debate. At the same time this purported strength can also turn into a weakness in that we are often quick to lose sight of what once considered a normal baseline.


I have often made the point that the emotional aspects of our human psyche are are completely unprepared for achieving success in the financial markets. A big part of that is recognizing context outside of recency bias – a cognitive inclination we all seem to share. For instance, if your system starts losing after months or even years of working fine – do you discard the system altogether, do you take a break from it, or do you simply keep trading through the rough patch?

Novice traders would probably take a handful of losses and then walk away. The worst approach in my not so humble opinion. More advanced traders probably split into the two remaining camps. I for one would most likely consider reducing position sizing for a while until I see concrete evidence that market conditions once again favor the particular system employed. Others would simply trade through it and quite frankly there is justification in doing that as most of my statistical analysis reflects that it produces superior outcome in the end. Nevertheless I personally feel uncomfortable with losses above 20R with a time frame of less than three months. So therefore I chose the former path, knowing that it lowers standard deviation in my SQN.

One of the big learning experiences over the years, and one I am quite regularly reminded of in my ongoing system development efforts, is that market conditions change on a constant basis. On an hourly basis every single system goes through a ongoing cycle of volatility. Some of that is clearly attributable to market hours and participation and being privy of it offers advantages in when to take positions, when to take exits, and when to wait for sideways tape to subside. On the daily charts things also cycle but it’s a lot less regular – you may see years with rarely any increase in volatility, except for the occasional obligatory correction.

The chart of the E-Mini above shows what I would call a pretty normal transition from a minor correction into an advance, after which we see a more thorough but pretty textbook intermediate correction. What follows is a strong reversal which  after a few weeks starts petering out but continues higher. The blue outlines highlight all the candles I would consider beyond two standard deviations during their respective period. It’s quite normal to see volatility explode higher during corrections which is a major seductive element of why bears are so eager to find red candles.


And here is the current view of the spoos in comparison. I actually should have done the reverse – highlighted all the candles which do not exceed what would have be considered two standard deviations over the past few years. Mathematically speaking the smaller ones are now becoming the outliers. And that tells us a lot about the market conditions we are operating in right now. We see in increase in gaps and fast reversals followed by even faster drops. And that chart does not even tell the whole story – for that we would have to post a series of intra-session charts, as the big moves happen mostly overnight when most U.S. equities market participants are locked out of managing their positions.

Which is why I’m rather surprised anyone is actually still active in this tape. Unless you are extremely skilled in playing the swings and suffer from chronic sleeping disorders at the same time (or are a trading robot from the future like Skynard) then your odds of success in this tape are rather slim. If you have participated in a traditional fashion (i.e. taking intra-day positions and holding them) then odds have it you’ve made several trips to the woodshed in the past six months or so. There are only two ways to approach high volatility sideways tape. And that is to either participate on a very short term basis – meaning playing the swings and taking profits before the bell. Or slow down your activities to a weekly and monthly scope and avoid all the intra-day noise. Of course the implications of doing that is taking entries at price extremes or major inflection points. Which sounds a lot easier than it truly is.

What I do keep emphasizing here is that this is not the same market we’ve been trading over the past few years. Yes, quantitative easing is still a major driver of investor confidence but one quick glance at the chart above would suggest that it is increasingly losing its effectiveness. Clearly the goal of the Fed and the ECB is that of market stability and they have both proven on numerous occasions that they will go to any length imaginable to stave off a major market correction, which is seen as politically untenable. Or at least that’s the popular argument and you may suspect that the truth is a bit more intricate – albeit outside the scope of this post.

It is quite possible that in a year from now we will look at this chart and scratch our heads wondering how we could have not see that the market was about to fall off the plate. Or nothing could happen and we just kind of continue higher, one quick headline fueled push after the other. I really don’t know – because if I was certain then I would be either buying a bunch of puts here or grab a truck load of long positions and be done with it.


But what I do know is that the bull market of the past five years most likely will not return. Central banks may succeed in propping up equity markets for another year or so but volatility is increasing rapidly and it must resolve at some point – one way or the other. My approach going forward will be to take stock of the situation near major inflection points and then assess my available options. I won’t be betting the farm but I am willing to employ a small portion of my assets toward a resolution.

I have two setups this morning but need to keep them for my intrepid subs:

More charts and commentary below for anyone donning a secret decoder ring. If you are interested in becoming a Gold member then don't waste time and sign up here. And if you are a Zero subscriber you get free access to all Gold posts, which gives you double the bang for your buck!

Please login or subscribe here to see the remainder of this post.


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