Zero Divergences

With all that’s going on I often forget that not all of my loyal Zero subs have been around for years. But recently a few noobs have signed up and thus it’s important to share the occasional titbit:

2014-12-03_Zero

Here’s a great example of a bearish divergence which occurred about an hour into the open. Now, I concede that it didn’t produce a big move but it’s the kind of stuff we look out for. In simple terms: if the signal is congruent with price direction then the market appears to be truthful – if you see divergences like these then pay attention as short term tops and bottoms often happen shortly after. Of course in such a compressed VWAP bubble we probably won’t see large gyrations.

Now the only exception are very strongly trending days – when the signal is above 2 (or below -2). On those days be very cautious about picking any ST tops or bottoms, unless there is a very pronounced divergence (even then proceed with caution). The same applies to the blue scalping signals. Look at the two signals yesterday – those were great conditions for a little swing trading. During trend days however it’s best to completely ignore them.

It’s not too late – learn how to consistently bank coin without news, drama, and all the misinformation. If you are interested in becoming a subscriber then don’t waste time and sign up here. The Zero indicator service also offers access to all Gold posts, so you actually get double the bang for your buck.

Cheers,

Market Weather Basics

In the past few years I have spent quite a bit of effort categorizing distinct market phases as they clearly can affect both discretionary as well as automated system trading. I often also refer to it as ‘market weather’ and my first treatise on the subject was two years ago in a pertinent post. It mostly focuses on the psychological aspects of how market gyrations affect trading behavior and distorts perceptions among market participants. In combination with a trader’s respective cognitive biases various market conditions will affect one’s daily activities. Whereas a swing trader may be perfectly happy and successful playing the swings in a volatile sideways market a trend or system trader may run into draw down periods, thus affecting discipline due to recency bias.

Of course there are various technical approaches of how to categorize market periods and among my favorites are Van Tharp’s SQN based approach or the StretchStat and VolStat indicators developed by Ken Long. Scott recently covered those in his posts, so if you want more meat on your sandwich then I suggest you point your browser here.

In today’s post however I want to go back to the basics as you don’t really need any fancy indicators in order to develop a pretty good ‘feel’ (if I may use that word) for categorizing various market periods on a chart. The human mind is actually pretty damn good at pattern matching – and with a bit of practice it’ll quickly become second nature. So let’s cover a few core markets of recent past, starting with the bonds.

This is actually a wonderful example as the difference in the two prevalent phases couldn’t be more salient. Starting in early January until the end of the month bonds pushed up significantly in what I would call a low to mid volatility trending phase. If you recall Scott’s treatise on the subject – that is a very common period and one I would categorize as easy to slightly challenging for the average trader. Of course your mileage will vary greatly – again for a trend trader this can be fun, for a swing trader this is more challenging as reversals/corrections are shallow.

The inverse speaks true to what followed – a high volatile sideways market which I consider the most difficult for most retail traders. The reasons for that are plenty and have been rather prolific on this subject and prefer to not repeat myself in this post. Suffice to say that anyone with a directional opinion or expecting resolution will be taken the woodshed all the way through Sunday.

Here is another example – the spoos on which I highlighted three distinct phases. The sell off in January was rather directional but with some volatility in the middle. What followed was a low volatility trending phase. Of course any indicators won’t tell you that until you’re halfway in but the human mind can easily pick up the fact that we have very few overlapping candles and most importantly 10 consecutive higher highs in a row.

Since about mid February things however got a bit more dicey and I would categorize the recent month as a volatile sideways period – once more the most difficult to trade for most participants. Psychologically also rather taxing and it has been taking its toll right here in the comment section (which has been rather quiet in the past two weeks). I always try to warn you guys when I see storm clouds on the horizon but often get the impression that very few are listening. Perhaps educational posts like these will serve to instill a bit more sensitivity as to when trading can be easy and when it can feel like helping Sisyphus push a rock up a steep hill.

Another example gold – I think one of the reasons why we have been rather successful in trading the shiny metal is that gold has the habit of switching between volatile sideways and trending phase with a mix of volatility, usually medium to heavy. You probably remember our gold entry in early February at which point I was expecting gold to continue trending higher. What I did not anticipate is that it would make a sudden u-turn but what’s interesting is that the market phase has barely changed – we are still trending and volatility is probably identical to what it was on the way up. So clearly we must differentiate between direction and market phase. For the seasoned trader direction may be insignificant but retail traders often get married to a particular direction, with the expected results.

And then there are charts which are almost impossible to categorize – I usually stay away from those unless I see then knocking on very pronounced inflection points (a subject for a different day). But when you look at a chart just like this – what do you see? What I see is acceleration followed by slower periods. In terms of volatility that creates a strange mix – the tape looks pretty directional but it’s rather volatile. But clearly this is NOT any easy chart to trade, would you agree?

Here is another example that may be even more pronounced – the fabled natgas contract Just look at how different these market phases are and I haven’t even bothered trying to categorize them. An accumulation of slow/sideways tape followed by quick spikes, long wicks, and sudden reversals. I also see a lot of gapping action and for a futures contract that is very rough to trade. Once again, stay away unless you really know what you are doing.

In summary – market phases are much neglected but integral part of trading and one you should come intimately familiar with. System developers often thrive to write systems that offer a lot of opportunity by being in the market all the time. That’s understandable but it is largely based on an unrealistic assumption that the same entry and campaign rules will work in all market conditions. Instead you will find that some systems promising only a very small or no edge may suddenly work extremely well if used only in the context of certain market conditions. To that end it is important that you sit down and document the characteristics and beliefs of your trading activities and then correlate them with the various market conditions you will encounter. Again, that in itself deserves its own post and I think Scott has definitely pointed the way.

My own work is strongly influenced by market categorization and without padding my own shoulder many here would agree that it has kept us out of various traps in the past. This morning’s spike higher for instance could not have been predicted but it had pretty good odds given what we saw on the Zero as well as in the context of the tape we experienced in recent weeks. Which is why I happily exited my TF trade yesterday according to the rules.

In essence what you always want to ask yourself is this: Does the current market phase impair or support my trading activities? In either case you can either change your current approach or just sit on the sidelines until you see better weather on the horizon. Unlike fund managers or professional traders you are only responsible for yourself and your personal assets, thus you are afforded the luxury of flexibility and the ability to be nimble. Once you are pushing a few hundreds of millions of Dollars around the dynamics of trading become quite different. It’s like the difference between driving a speedboat and an oil tanker. Say what you will – the speedboat is a lot more fun and if you’re lucky you’ll enjoy attractive company in sexy bathing suits.

Well it’s been a rough week and now it’s time to kick up our feet and crack open a cold one. I see you all next Monday morning.

It’s not too late – learn how to consistently bank coin without news, drama, and all the misinformation. If you are interested in becoming a subscriber then don’t waste time and sign up here. The Zero indicator service also offers access to all Gold posts, so you actually get double the bang for your buck.

Cheers,

Seven More Reasons Not To Be Long

Let me precede this post with a warning: I am not saying that it’s impossible for equities to push any higher. Quite on the contrary – there are signs that indicate that we soon may run into a little short squeeze. If that outlook sounds contradictory to you then you may want to go back and read Volar’s excellent excerpt on platykurtotic vs. leptokurtotic markets which he posted almost a year ago. Simply put – it all depends – August is a good month for trend traders and if you are betting on mean reversion you may get burned.

Now as stainless steel rats we are sworn to trade by our rules (whatever they are) and to only take setups which strongly suggest that the odds are in our favor. And it’s that last little detail that is the problem right now – momo and sentiment is all over the place.  Meaning if you look hard enough you will find plenty of reasons to be short and plenty of reasons to be long. Unfortunately as human beings we all have a tendency to discard information that contradicts our current point of view and at the same time embrace information that supports it. Which easily translates into trading losses.

The purpose of today’s post is to show you the upside risk that is present right now. If you are a trend trader then you don’t care as you have been long for a while and your rules tell you to stay in until your stops take you out. Your system thrives on leptokurtotic markets and the few times you get away with it you win big. For the rest of you guys I have collected seven charts that demonstrate why holding long here represents significant risk. Over the next few days these charts may be meaningless but medium to long term I believe that their combined message advocates caution.

Exhibit 1 – the Dow vs. the TRAN: According to Dow theory those two should on average be moving in the same direction. When the performance of the average diverges it is a warning that change is in the air. Again, bear in mind that this is a long term chart – nevertheless it started to detach in July and the present divergence resembles a mirror image.

Exhibit 2: Similar situation on the Russell 2000 which obviously represents quite a bit more risk than the trannies. That little trend line I painted has been breached but I’m still labeling this as divergent.

A lot more where this came from – I will also show you two charts that suggest that we may head into a short squeeze before gravity sets in. As the old saying goes – the bus moves fastest once everyone got off. Please step into my lair:

More charts and cynical 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 or Geronimo subscriber it includes access to all Gold posts, so you actually get double the bang for your buck.

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