Tops Are A Process
This weekend I don’t see much in my LT chart collection that bodes repeating. Our P&F charts have been spot on recently and as I have produced some updates this is an opportunity to share some pertinent musings with my subs. However, the overall take away message I would like to convey today is that tops (as well as bottoms) are a process and that they take time. This is a concept many retail traders have a hard time embracing, usually much to their own demise. Observe:
Once again we are looking at volatility plotted against the SPX, more specifically we are plotting a ratio between the vanilla VIX and the VXV, it’s 3-month cousin. There is method to my madness as this ratio, when plotted on a long term basis, often provides us with hints of what may lurk behind the distant horizon. More specifically we are interested in divergences which happen when price moves in one direction and our ratio starts pushing in the opposite.
I have highlighted the most salient occurrences and it’s surprising how we start seeing the ratio plot a divergence almost every single time, weeks ahead of prices forming a top. This again demonstrates that markets can stay irrational a lot longer than you can remain solvent. When attempting to short market that’s in squeeze mode you are almost guaranteed to get burned. Remember, you don’t get points for being first – what matters is catching the bus when the time is right. And on a long term basis we have a lot more time than we think. Very rarely do markets turn on a dime. It has happened but it’s the exception.
Right now we once again are seeing a divergence but in comparison with prior ones it’s minuscule. Which means that on a long term basis we ought to give this rally a lot more leeway before we even start thinking about short positions.
Here’s a similar example – the SPX vs. a ratio between NYSE stocks above their 50-day SMA and the ones above their 200-day SMA. Obviously the latter are considered more supportive of long term growth than the former. Again two key observations: 1 – tops take a LOT more time than you think. 2 – we are just now starting to form a divergence.
So does this mean the SPX is bound to make a b-line to 1600 or 1700? Of course not – these are long term charts and thus we need to be thinking in weeks and months, not in days. Even if we are going to paint new highs this year, the path upward will be littered with short and medium corrections. To us traders they of course matter the most but it’s always good to remind ourselves what the prevailing long term trend is. And as of now it remains to the upside.
Now let’s look at some P&F charts – specifically the SPX is currently making my head spin:
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This entry was posted on Sunday, January 27th, 2013 at 1:41 pm. Both comments and pings are currently closed.