Happy New Year!

Okay, as we’re getting close to kissing 2010 a last goodbye it’s time for ole’ Mole to start switching back into productivity mode. The only new year resolution on my mind is for us stainless steel rats to continue banking coin and to avoid the plethora of traps that are being thrown at us on a daily basis. The past two years have forced me to up my game quite a bit and as such I actually in some ways consider the nastiness we had to endure a positive experience. Of course the biggest change for me was the realization that the long term window is way to elusive to be factored into a reliable trading approach these days – thus I have narrowed my trading window to from originally weeks/months to now days/weeks. Far from being a mere instinctual decision this new short term approach has been heavily influenced by several factors:

• My shift from a mainly EWT based approach toward development of a more sophisticated set of momentum and sentiment indicators.
• A profound change in the inherent nature of the equity markets, e.g.:
  • extreme conditions persisting for much longer
  • retracements becoming more flat
  • increase in volatility (price/sentiment)
  • volatility extremes occurring within shorter time frames
• A a shift in participant demographics (i.e. an explosion in HFT traffic, the exodus of retail traders, a smaller group of more Fed assisted TBTF primary dealers, etc.)
• Increasing evidence of how POMO auctions can and have affected equities inflows and outflows; and an marked increase in the frequency of POMO auctions (i.e. QE and now QE2).
• The realization that given these conditions a daily/weekly trading window increases the odds and also insulates a trader from being led astray by sentiment extremes or blatant Fed manipulations.

Looking at the above list one wonders what approach actually works reliably in such challenging market conditions. Long term success in trading was was never easy to begin with and thus was limited to a very small minority of players who were either connected or able to detach themselves from being anchored into a particular way of thinking (i.e. bullish vs. bearish). As such the turbulence experienced in the past two years led many once successful traders to the sidelines – either by choice or by sheer force via Darwin’s principle suggesting survival of the fittest.

I am now convinced more than ever that one of the few survivors of those rapid evolutionary changes in market conditions is the Zero indicator. While many indicators turned to mush in continuously overbought conditions, the Zero has kept us one step ahead. In the past few months I have often praised the daily Zero for keeping us on the right side of the term trend during inflection points that were often interpreted by the usual pundits as being opportunities for taking contrarian positions. However, all the while the hourly and in particular the Zero Lite (ZL) has been kicking ass and taking numbers. I’m posting a simple screen grab of this week’s rather boring tape to elaborate on my thoughts:

I am sure many of you have heard the expression referring the combination of certain things being larger than the sum of their parts. To that end I am quite certain that adding the commonly used VWAP to the ZL chart is a textbook example of just that line of thought. Alright, let’s get a bit technical: Quite simply – having watched the spoos bounce within the VWAP bubble for years now (i.e. VWAP in white as center inside a 2.0 standard deviation bubble) the game has traditionally been in guessing or predicting whether or not prices will either push above or below the VWAP line and of course if a push to the outter StDev bubble was a possibility. Finally, if prices were approaching the StdDev bubble on either the up or down side whether or not a retrace was likely or if prices would cling to that level and perhaps even breach beyond. That’s in essence how one trades VWAP – other approaches may exist, I’m sure, but most traders I know play it according to that simple set of rules.

Now, if you look at the chart above it’s rather easy to correlate various prices moves within that VWAP bubble with the ZL signal. More precisely – the one consideration for a swing trader or scalper now becomes whether or not the ZL signal supports a particular price move in the context of its position in the VWAP bubble. Key considerations before taking a trade now are:

• Is the ZL above or below signal? That’s our most basic consideration as the zero mark delineates between an up or down trend.
• How long has the signal stayed above/below the zero mark? The longer the more sustained the current short term trend.
• Is the signal weakening? Example of that are pushes higher in combination with a positive but diminishing positive ZL signal.
• Is there a divergence between signal and price? This kind of ties into the prior point but is considered a more pronounced situation in which prices are for instance painting new daily highs while the signal is clearly dropping off and maybe even dropping below the zero mark.

I believe that the combination of VWAP and ZL signal makes for a very powerful trading framework in which various systems could be developed. In the past year I have mostly been following this approach manually just like the rest of you whenever I was able to actually stare at the ZL chart all day. But many of you have been clamoring for a more automated way to follow the Zero and I believe that the framework presented above warrants a more systematic approach. However, before I sit down and start slinging NinjaTrader code I would very much enjoy some input from my intrepid gang of stainless steel rats. Many of you have been faithful Zero subs for over a year now – so quite obviously this thing is giving you some kind of edge. How about you digest some of the above and then report back right here with propositions, examples, and perhaps even rules for coding into a system. And yes, posting of annotated Zero charts is fair game – knock yourself out 😉

Oh yes, and before I forget:

Go crazy and have a blast within your legal limits – wherever you are. For fuck’s sake – for all we know we only live once, so let’s make 2011 a year to remember.

Yours unfaithfully,

Mole