The Plot Thickens

If you followed Scott’s RTV Sell setup on the SPX today then I assume you are holding short positions right now. There’s an old saying in trend trading: There are good entries and bad entries but in the end they are meaningless because it’s the exit that makes all the difference in the world. Obviously many of you are not trend traders and a RTV Sell setup is clearly a contrarian and not a trend trade – it’s a bet on a change of the ongoing trend near its peak. Which means you exchange higher odds of being right (via continuation) for a prime price entry (i.e. near a reversal point).

What you should care about right now is whether or not your trade will prove you right or wrong. The wrong part is rather simple as all you need to know is your stop – in this case it’s yesterday’s highs at 1352.25 (again, per Scott’s charts). What’s a bit more tricky for many many traders I have talked to is when trade is proven to be right, when a trade is reaching max potential, or when the trade has worn out its welcome and it’s time to get out and call it a day.

About 50% of the traders I met are way too fast on the trigger finger and ruin their profit potential by taking profits too early. Then there’s about 30% who make it to the prime profit potential – which is near a reversal. The other 20% usually stay out their welcome and have to give up profits. For the record – that is of course a very rough generalization as it also depends on what type of trader you are. A trend trader will alway always take profits ‘too late’ in the mind of a swing trader and the concept of ‘being late’ is entirely debatable as it depends on your time frame and your exit logic. The challenge for me as a financial blogger is to post charts that assist various trading approaches and time frames – which as you can imagine can be a bit tricky at times.

Anyway, not to delve into academics – I do have a point here. Whatever your system, if you are short right now then there’s nothing for you to do unless you either get stopped out or we approach some of the support levels I’m going to point out. If you are lucky enough to properly catch a turning point early on (via an RTV buy/sell, an inside candle, etc.) it is key to alwayst assess both the macro and the micro picture.

I think we all agree that the macro picture is extremely overbought right now – Volar, Fearless, and yours truly produced a ton of evidence to that affect over the past few weeks. This has important bearings on the type of correction we may expect. My weekend post suggested that the bulls were not out of the woodwork just yet and that we just may see a RTV Sell setup.

And thus far this is exactly what we got, which means we are short now until we are at target or stopped out. Now I know what my target is but that might not be yours. If you are a short term swing trader then your target may be as soon as ES 1330.25, which is our lowest NLSL on the daily chart right now (which at the current fair value would be ~ SPX 1333 – give or take a handle). The hourly is showing us support as early as 1337 and since I took this snapshot we already touched that level. What happens next will be key in deciding as to whether to continue your trade or to take exits early.

You may also keep an eye on the VIX as it approaches its upper BB boundary. A close outside may lead us to a VIX buy signal (relative to equities) and those have worked rather well in the past few years. So how volatility behaves in the course of continued selling should be an important aspect of how you assess further downside profit potential – no matter if your time frame is days or weeks. Does anyone still trade months these days? 😉

Something that really surprised me today was the vehemence of the USD/JPY – and if you consider those ever expanding candles then it’s probably wise to not underestimate the possibility of a continued short squeeze.

Which brings me back to the longer term potential – which remains to be mixed. In order to break the current medium to long term up trend we will need to breach important long term support levels and we are still miles away from doing that. We would first have to see a rallying VIX inside a rising Bollinger bubble and various support lines smashed into pieces. Now, if that happens then we are facing a situation in which overbought sentiment has finally aligned with price and that opens the door to a very meaningful downside correction. Let’s also not forget that we are still in the month of February, so seasonality would invariably play its part.

So, if you are short today as a long term trader then it may be worth holding out for that – which means you may trade this thing down and all the way up again, long after short term traders collected profits and called it a day. You may even get stopped out a few days or a week from now – for a short term trader this would constitute throwing away a good trade but for the medium to long term trader this is merely the cost of doing business. He/she will be right one of these days and collect handsomely as a new trend establishes itself – which is usually rather violent and rapid on the downside.

A few more charts to round out the current landscape – please step into my dusty lair:

What’s fascinating is that we had an inside day on the AUD/JPY as well yesterday but we breached yesterday’s highs and are already painting an engulfing candle. This could easily continue higher and given VIX and short term support puts us at an inflection point that will define the medium trend for the coming weeks. A failure here for the bulls would be lethal and may trigger the implications of the medium to long term sentiment extremes we’ve presented here for the past few weeks. As usual watch the AUD/JPY after hours as a good indication of what to expect on the equity side. The current non-correlation is curious and bears further attention.

Cable also has dropped a bit further since I took this snapshot – I think 1.5624 needs to hold or we’re going to the bottom of both Bollingers.

The NZD/USD is tickling its NLSL and I would be long here until we drop below 0.8285. If that happens I will go short and hold into 0.82.

EUR/JPY still battling its 100-day SMA, which makes it that more important. I think a breach below today’s engulfing candle will take it to the daily NLSL at 100.38. A breach above today’s highs most likely takes us all the way to 108. Either way – a juicy trade and I don’t intend to miss it.

Cheers,