Volatility Games

As you know at best I usually ignore the news. And often I even fade whatever popular theme makes it to the top slots of the daily headline queue, anticipating that retail once more is being led to the slaughter by the usual suspects. Then there are those times when the risk/reward ratio of being in the market is so skewed that the best policy is to just hunker down and wait things out. This quite often occurs during limbo periods – if you don’t know what I am talking about then please take some time to peruse last Sunday’s post.

Today I however want to dig a bit deeper into the concept of volatility – or more precisely volatility in volatility (ViV):

If you are confused by the meaning of ViV then take a look at the chart above. This is simply an hourly plot of the VIX in blue/green with average true range (ATR) plotted below in yellow. As you may know average true range represents volatility – ergo, we are looking at VIX volatility here, which just happens to plot volatility in itself. Thus ATR on the VIX represents ViV.

What you usually want to see as a trader is for the VIX and ViV to move more or less in unison. When I see ViV rise I usually take note as we may see a bit of a storm. But when I see the VIX drop hard and ViV push in the exact opposite direction then tornado alarm bells go off in the evil lair.  And divergent ViV is exactly what we are seeing right now.

For the subs I do have a few perspectives that may unfortunately not predict where we’re heading on Monday morning but demonstrate why being exposed right now is not only a very bad idea but that chasing whatever direction the tape may taking early in the session could result in a good ole’ spanking. And not the type you may enjoy 😉

While equities shot higher late Friday our TLT:JNK ratio has been going sideways. What does that tell us? Well, it seems that credit traders are a lot less enthusiastic about the rumor mill that has been so conveniently stirred up ahead of the Greek election. Can we trade on this? Hell no – but we can decide NOT to trade. And knowing when to stay out is often more valuable then when to take a trade.

FAGIX vs. VUSTX – same story here. Credit is not buying the hype right now.

Copper is still irking me. This is not an easy chart to read and I’ll try to explain it. The orange arrows I painted show us how both moved in unison on the way down – most importantly we are seeing a similar level of magnitude. On the way up (if you could call it that on the copper side) we are seeing equities pull away hard. I know we are above 1330 right now but that does not give me much confidence in the current push higher.

Interesting perspective over on NYSE up vs. down volume. The divergences at both the top and at the bottom are sure noteworthy, yes. But what really gets me is the magnitude of the recent ratio spike up in comparison with the spike down. Seems to me that a lot of energy has been expended to get the tape above 1330. Can we trade on this information? Hell no! But ask yourself this – IF we spike higher on Monday then what are the odds of a sustained move higher without seeing a shake out first?

Very same picture on my NYSE adv/decl issues ratio. Divergences  – check – we always like those near tops/bottoms. But the magnitude here is rather large and even if we spike higher Monday I would not expect for this ratio to make a b-line for 2.5. And if we drop hard then the same applies: This is just too juicy of an opportunity to shake out some weak hands, especially if they happen to trade according to the headlines.

Bottom Line: We are heading into a tornado on Monday and I think there will be a few big winners and a lot of sour losers. I don’t see why anyone would want to participate with anything more than a few lottery tickets. Don’t be worried about missing the boat on whatever direction the tape will take. Rather be worried about losing a large chunk of your trading equity. Let’s remember that our prime directive is and will always be capital preservation.

As they say on my side of the Atlantic: No vale la pena 😉

Cheers,