Monday, August 24, 2015

Trading Notes: Week of 8/24/15

Friday, August 28th

*  Buying weakness yesterday ended up being a useful strategy for much of the day, but a strong selloff and then buying reversal in the last two hours of the trading session made for volatile trading.  I continue to expect these volatility aftershocks to be with us, as noted in Wednesday's post.  That being said, the pure volatility measure has been generally trending down over the past several sessions, though it's still at historically high levels.  

*  The pattern of improving breadth has continued.  Interestingly, we had 131 stocks across all exchanges register fresh new monthly highs and 136 make new lows.  That new low figure compares with 726 and 840 during the prior two sessions and 3553 at what appears to be a momentum low.  As long as we see higher prices, strong NYSE TICK readings, and improving breadth, my game plan is to buy weakness, particularly if it can hold above the overnight lows.

*    Pertinent to the issue of declining, but still high volatility, is the decline in volume in SPY over the past several sessions.  We peaked at 507 million shares traded on Monday, then roughly 369, 339, and 275 million the past three days.  One of my quant routines estimates the likely day's range (very helpful for establishing price targets on trades), with volume as a major input.  By seeing how today's volume unfolds, we can estimate the likely day's volume and make informed estimates as to likely price range for SPY.

*  A measure of the breadth of market strength that I track daily is the number of NYSE shares that give buy vs. sell signals for various technical measures.  Yesterday we had 520 buy signals vs. 20 sells for the Parabolic/SAR measure.  We've had 11 occasions where we've had over 400 buy signals on that measure since June, 2014, when I began collecting the data.  Three days later, SPY has been up 8 times, down 3 for an average gain of +.49%.  It's too small a sample to hang our hats on, but does serve as a nice reminder that strong upside thrust leading to a short-term overbought situation (over 90% of SPX stocks are above their 3- and 5-day moving averages) does not necessarily lead to "mean reversion".

Thursday, August 27th

*  Per yesterday's post, we did indeed see a test of lows in Wednesday's session, followed by significant buying.  The NYSE TICK has provided very good tells for the recent market action, as broad downticking was followed by broad upticking very early in yesterday's rally.  That strength has continued into the overnight, all of which is consistent with the idea of having put in a momentum low per Tuesday's comment.

*  Another good tell in yesterday's trade was the continued drying up of the number of stocks making fresh new lows on weakness.  We had 726 monthly lows across all exchanges yesterday versus 840 on Tuesday and 3553 (!) on Monday.

*  The pure volatility measure continues at high levels, suggesting that volume and volatility might be with us for a while.  We remain above 30 in VIX, off the highs but significantly elevated relative to most of 2015.

*  I find that the psychological issues faced by traders in this recent market are related to difficulty adapting to the recent changes of trend, correlation, and volatility.  Per the recent Forbes article, a big part of emotional upheaval in trading comes from the mismatch between the patterns we've become accustomed to seeing in markets and the new patterns that are playing themselves out in current market action.

*  I note that 89% of SPX stocks are now trading above their three-day moving averages, but only a little over 2% are trading above their 10-day averages.  I expect that latter number to increase significantly, as our correction from the recent weakness plays itself out in time as well as price.  My game plan is to be open to buying weakness as long as we stay above the overnight lows.

Wednesday, August 26th

*  The break of the 1920 level in ES referenced yesterday showed us that the China cut was not a game changer, and we continued the volatile downward market.  Interestingly, fewer stocks made fresh new lows yesterday relative to the day previous.  Specifically, we had 3553 monthly lows across all exchanges two days ago and only 840 yesterday.  This would be consistent with having put in a momentum low, which on major declines can precede ultimate price lows by weeks or even months.  

*  Yesterday we had fewer than 5% of all SPX stocks trading above their 3, 5, 10, 20, and 50-day moving averages.  Going back to 2006, there have only been four occasions in which we've seen similar broad weakness:  10/7 and 10/9 of 2008; 11/20 of 2008; and 8/8 of 2011.  Over the next three trading days, SPY moved -9.74%; 9.68%; 13.95%; and 4.75%, respectively.  Note the very high volatility going forward.

*  Note also that the dates above did not make ultimate price lows for a number of months, but ultimately led to major bull market moves.

*  I am alert for the possibility of our putting in lows near term and am watching that 1830-1850 level in ES closely.  I would expect the combination of short covering and value buying in the high volatility environment to create a major snapback rally from these very oversold conditions.

Tuesday, August 25th

*  The volatility alert proved useful for Monday's trade, as we blew out to a VIX of 40 by the close and traded with a daily true range in excess of 8%.  We traded well off the day's lows, inviting the hypothesis that we've seen a momentum low for this down move.

*  Contributing to the idea of a momentum low is the unusually broad, weak breadth.  Over 400 SPX stocks made fresh 20 day lows yesterday.  We haven't seen that kind of broad weakness since early August, 2011.  That indeed was a momentum low, but note that stocks drifted lower, albeit with fewer stocks registering new lows, for a couple of months after that.

*  I will be watching commodities closely, as these have been a useful alert for EM equity weakness and weakness in U.S. stocks.

*  I will also be watching the ES 1920 area, as that was the most recent low prior to the China announcement of a reserve ratio cut.  If that move by China was a game-changer, that level in ES should hold.  Game plan is to buy weakness that holds above that 1920 level.

Monday, August 24th

*  There's a very key point toward the end of the recent Forbes article:  many times what we interpret as a trading problem actually represents *information*.  For example, the trader who has difficulty pulling the trigger may very well intuit that the market environment has changed and that what had been good risk/reward may not be so at the moment.  Similarly, frustration could be a very good early, emotional signal that regimes have changed.  We spend a lot of time trying to prevent and combat emotions in trading when perhaps we should be focused on learning from them.

*  With respect to the recent article, also note the five things I look for to identify changing regimes.  Very helpful in adapting to market conditions.  These will be relevant once we're ready for the bear to turn.

*  We continue to see price behavior that is wildly different from what we seen through most of 2015.  For example, from midnight to 8 AM EST so far today, we've printed 150 bars based upon 500 ticks of price movement.  By contrast, on the Monday two weeks ago, from midnight to 8 AM we printed 6 such bars.  My pure volatility measure continues to make new highs, meaning that we're getting more movement from more volume, but also more movement per unit of volume.  This makes risk management tricky, as we tend to rely on the same time frames for holding periods without realizing that holding a trade for a hour now is like holding for a day earlier in the year.

*  We closed Friday with fewer than 5% of SPX stocks trading above their 3, 5, and 10-day moving averages.  That kind of broad short-term weakness has been more typical of 2010 and 2011 markets than recent ones.  Very often, when we've had such broad weakness, the first thrust down has been followed by further weakness, which is what we've seen overnight.  I continue to favor selling bounces until there's some evidence that selling pressure cannot continue to yield weakness across the vast majority of sectors.