MOMO Update

I may as well move my butt to Australia now as most of the productive discourse in the comment section seems to be happening during nighttime in the U.S. Much of this clearly is due to Scott’s untiring willingness to lend a helping hand. And as grateful as I am for his contributions I am however horrified by the level of inexperience reflected in many of the questions. Clearly over the years we’ve seen a quite a bit of reshuffling here in our audience. Just go back a few years and look at the comment stream – many of those people have long disappeared. Some of the old timers retired (hopefully happily and flush), others chose to move on after having reached self sufficiency, but unfortunately a much larger number never managed to do what it takes. In the end they either got wiped out or decided to call it quits after hopping from one flawed approach to another (or perhaps got led into ruin by shysters). The financial markets have always been an attractive destination for gambling types bent on ‘trying their luck’ at brain surgery whilst being incapable of properly peeling a lemon.

My point here is that 90% of the material that Scott shared as of late has been covered here over the years and in much detail. Perhaps it is all my fault for not featuring some of our favorite posts of the past more prominently. Until I get around to placing them in a more accessible place I strongly recommend that you all point your browser to our favorite posts page and work your way through a veritable laundry list of hands-on trading knowledge. There are also quite a lot of handy tools under our – you guessed it – tools menu. There is simply no excuse for not understanding key concepts like position sizing (as in R), SQN, expectancy, etc.  And how can you even think about trading futures/forex without our handy risk calculators?

Again perhaps I only have myself to blame for not featuring our educational stuff more prominently. Please understand however that after eight years plus of running this blog I am oftentimes tired of regurgitating material I deem to be essential for survival in the financial markets. But clearly my audience is hungry for this stuff as every time it’s being covered here the comment section explodes and subscription rates increase. Hint taken and I’ll do my best to selectively cover these things again – perhaps one educational post per week? I’m open to suggestions.

Alright – with that covered let’s talk market momentum today – we are at an interesting stage here as the annual ritual of a pre-XMas-Rally-Shake-Out seems to be gaining credibility.


So let’s start with the easy stuff. You may recall that about a week ago I proposed that we would shift into a sideways depleting volatility cycle. However I was wrong about the sideways part as we actually transitioned into a trending depleting volatility period. One which now has us back in our ‘normal’ volatility range pre-sell-off. I put the word normal in quotes as volatility is a very relative concept and there simply is no ‘normal range’. You can define certain ranges as historically low or historically high but your normal range is always the current range – if that makes any sense.

That said, given the current readings it is reasonable to suggest that in the near future we are most likely not going to see the large daily ranges of the past two months. However given recent ranges and the fact that we are heading toward the base range does permit another increase in the near future.


Before we talk about the implications let’s take a peek at the long term picture which has us solidly above a weekly NLBL with a monthly NLSL in close grasp. Both of those are very bullish long term signals, in particular in the context of an impending X-Mas season. Very rarely do we see large sell offs during November or December – it’s not impossible of course but as traders we deal in probabilities. So let’s look at the current momentum.


We start with our trusted VXV:VIX cross – if you are unfamiliar with VXV then Google is your friend. In short the VXV measures quarterly volatility expectations whilst the VIX uses a mixture of the near term month VIN and the VIF which represents the far term month. Not to be confused with the VXO show below, which is the old VIX – again Google is your friend.

The ratio shown is a 3-day SMA which has been forming a pretty pronounced falling diagonal and we’re right at the upper range. That suggests to me that we may be seeing a little shake out here in the coming weeks, most likely concluding in early to mid December. As this is a long term chart I wouldn’t be surprised to see another stab higher (as volatility is depleting, leaving room for more trending tape).


VIX:VXO is basically the short term brother and here I am comparing *front month to front month* – the main difference is that the VXO measures options near ‘at the money’ (ATM) whilst the VIX is more weighted via VIN and VIF. The difference is that the VIN covers the entire front range of the near term month while the VXO covers near ATM premiums of both the near term and far term months. I know – a bit confusing and it makes my brain hurt as well.

Now this ratio seems to be building its own falling diagonal but if price doesn’t respond soon then we most likely will see another push higher before a shake out. This has happened back in April/May of this year. Since this is more short term I would use those diagonal touches for quick sell off opportunities or profit taking. I’ll be sure to post it here in the coming months.

Okay, but now let’s get to the good stuff 😉

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Words to the wise: I am not trying to predict the future here, all I am highlighting are probabilities at the current state of affairs. Things are constantly in flux and thus can be leveraged quickly by surprise moves. But until those happen I would propose that the bulls run the tape into early next year with a little shake out on the way in the interim before Christmas.


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:

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Running Like A Hare

The tape across the board has been running like a hare and today’s session again did not offer us any reprieve from the relentless battering we’ve been through over the past few weeks. Up and down she goes although on the equities side it’s been more down than up and the fat lady hasn’t sung just yet.


Clearly I’m going to be limping behind here as things are unfolding quite rapidly. When I took that snapshot it was looking like equities may have found some ground but I simply didn’t trust it and posted in the comment section that it’s probably best to let things play out. That seems to have been good advice as the spoos are heading even lower as I’m typing this. To your collective benefit Mole’s instincts have been honed by decades of hairy tape 😉


The Zero is still showing us very little participation, once again indicative of a stop run by institutional traders. A lot of greedy retail rats are being burned here folks – consider yourself lucky you’re not one of them (I hope!).


The NQ printing lower highs and lower lows – this is not looking good. The 25-day SMA only offering soft support and this thing could easily resolve toward the 100-day SMA near 4317 before it’s all over.


On days like these it always pays to check breadth and momo charts. The VIX:VXO is showing me no divergence which is concerning.


More long term the VXV:VIX is also pointing down. That’s bad medicine…

Alright, updated across the board in no particular order:


The EUR/USD is now in earshot of my target and I’m taking everything but 25% of my position off the table. This campaign has done a great job of softening the impact of the shitty exchange rate I’ll probably be facing in the months ahead. Notice the weekly NLBL that has been sliced today.


EUR/JPY – same idea here – I’m taking almost everything off the table, only keeping 25% of my original position. Again my target is near the 100-day SMA where I would normally expect some obligatory resistance. But given the velocity of this short squeeze things could easily overshoot.


Crude – I’m quite stunned by how well this one has kept up given all the drama in the remaining futures pits. As you may remember I snagged a rather early seat near the 50 mark and remain determined to ride this puppy higher. Over the past week or so there was a lot of talk about crude having hit a high and I’m glad I didn’t listen – as always! 😉


ZF is not a setup yet but I like the daily and weekly panels here. As soon as it gives me an excuse to be long I’ll let you know.


Ditto on the 10-year futures but it’s a bit early to snag a position just yet. Let’s see how things play out Sunday night or on Monday.

Alright before I grab dinner a few juicy setups for my intrepid subs:

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