Monday, April 04, 2016

Trading Notes For The Week Of April 4, 2016

Friday, April 8th

Insightful post on the misery of bull markets from The Reformed Broker.  Many traders are temperamentally long vol; the one prediction you most rarely hear is one for little movement and little price change.

*  Going back to 2010, if you take the number of 5-day new highs minus lows among SPX stocks and compare those to 20-day new highs minus lows, you get an interesting view.  When that time series is divided into quartiles, we find that when 5-day new highs/lows greatly exceed 20-day highs/lows, the next five days in SPY average a gain of only +.04%.  When 20-day new highs/lows greatly exceed 5-day highs/lows, the next five days have averaged a gain of +.39%.  (Raw data from Index Indicators).  Think of the implications for FOMO trading...

*  We reversed Wednesday's strength yesterday, closing with 5-day new highs/lows well below the 20-day level.  Less than 20% of  SPX shares closed above their 5-day moving averages and, for the first time since this rally began, fewer than 50% of stocks closed above their 20-day averages.  My cycle measure is now neutral, as we work off the recent strong readings (see below).

*  VIX has jumped to above 16 with yesterday's drop.  I have built a model that predicts a normal VIX level from two variables:  recent price change and recent realized volatility.  When VIX is more expensive than the model predicts it should be based on historical precedent, returns have been positive; when VIX is more cheap than the model predicts, we have seen subnormal returns.  Thursday of last week through Monday of this week, we hit cheap levels in VIX valuation.  With yesterday's drop, we are back to being expensive in VIX pricing.  To give an idea, going back to 2012, when VIX has been in its most richly priced quartile, the next five days in SPY have averaged a gain of +.76%.  When VIX has been most cheap, the next five days have averaged a gain of only +.03%.  In short, when options participants price in too much vol, we tend to get higher prices--which implies a mean reversion in vol!

Thursday, April 7th

*  What would a startup community of traders look like?  Love this post from Howard Lindzon, mainly for the entrepreneurial zest I see missing among so many traders and trading firms.  Amazing what a difference it makes to be surrounded by innovators who bring vision and optimism to the future.  I see precious little of that in the trading community.

*  Stocks found solid buying yesterday in the wake of oversold readings, but have pulled back in overnight trade.  My intermediate-term strength measure, which looks at new highs versus lows for SPX shares on three different time frames, continues to work off its extended readings.  Many of my cycle-based measures look similar.  We're getting fewer new highs among stocks and new lows have ticked higher the last two sessions.  Yesterday, across all listed stocks, there were 467 new monthly highs and 417 new lows.

*  Using data from the Stock Charts site, I track the number of NYSE stocks giving buy versus sell signals across multiple technical indicators, such as Bollinger Bands, CCI, Parabolic, etc.  Here too we see the waning strength recently.  My measure of breadth volatility (the volatility of breadth readings) has picked up lately from low levels and that generally has been associated with weak returns.

*  Housing (XHB) has been relatively strong.  Not so much commodities (DBC).  Notice the strength of euro and yen versus the US dollar (FXE and FXY).  Hard to believe that is what ECB and BOJ want to be seeing; note the relative weakness of European (VGK) and Japanese stocks (EWJ).

Wednesday, April 6th

*  We can't change our behavior unless we're aware of our behavior patterns.  Here's a great post on self-awareness and trading from Tradeciety.

*  The pullback in stocks continued on Tuesday, giving us the first real negative breadth reading we've had since the rally launched in February.  (See chart below).  Across all exchanges, 270 stocks made fresh monthly highs and 492 registered new monthly lows.  (Data from Barchart).  Only about 10% of SPX shares closed above their 3-day moving averages and about 15% above their 5-day averages (data from Index Indicators), telling us that the pullback has been broad.  VIX has climbed above 15 and we saw greater put buying across individual shares.

*  Yesterday I noted the expansion of buy signals for stocks on the Stock Spotter site; those signals expanded even further after yesterday's weakness.  This has generally been positive for SPX.  Their cyclical model for SPY is also quite bullish, which has backtested well.  While I'm viewing this as a pullback in a bull phase of a cycle and expect a retest of recent highs, I will be watching the vigor of any bounce carefully.  Given the breadth of the recent weakness, it would not surprise me if we were to enter a more prolonged topping/range period.  We should see pronounced breadth divergences on forward strength if that scenario were playing out.

*   Note the considerable strength in high quality corporate bonds (LQD).  As noted a little while back, these are natural candidates for those seeking yield.  On the other hand, high yield bonds (JNK) have been relative underperformers.  This is a defensively minded market, which could also be why US shares have been outperforming overseas ones (EFA). 

Tuesday, April 5th

Excellent post on trading strategy and tactics from The Crosshairs Trader.  Very helpful in developing trading plans.

*  We've seen a pullback in stocks and, with Monday's close, now have fewer than 50% of SPX shares closing above their 3- and 5-day moving averages.  With 831 monthly new highs and 288 new lows, we're still not seeing significant deterioration in the breadth data.  Energy stocks have been the weakest group given the recent oil weakness, but I'm not seeing significant weakness among any of the sectors.  Financials have been relatively flat of late, so I have a close eye on those.

*  The realized volatility of VIX has hit levels that have been consistent with past market peaks.

*  I noticed that, as of yesterday's close, we had an elevated number of buy signals on the StockSpotter site.  I continue to be impressed with their work.  Their forecast model for SPY also is bullish.  When those two factors have been present since late 2013, when I first began tracking their numbers, returns five to ten days out have been bullish.  Specifically, we've been up 19 times, down 8 over the next ten trading sessions for an average gain of +1.17%.  

Monday, April 4th

*  Long-term success, in trading and in life, means sustaining our passions.  Here's how we do that.

*  We're seeing fresh highs this morning and have almost entirely erased the drop from late December.  Friday closed with 767 new monthly highs across all exchanges versus 217 lows.  Still no significant expansion of weakness in the upticks/downticks data, as we closed Friday at fresh highs.  Note that the cumulative upticks/downticks measure has vaulted above 2015 levels.

*  Among SPX shares, new 100-day highs outnumbered new lows by 127 issues (data from Index Indicators).  That is the strongest breadth reading on that measure since the rally began in February.  The last time we had a reading that strong was late in 2014.  Note how we have stayed overbought in the new high/low measure for a considerable period, attesting to the momentum of this rise.

*  Note how oil has been moving lower day after day, even as stocks have rallied to new highs.  The oil drop is noteworthy, coming on the backdrop of a weaker dollar.  High yield corporate debt (JNK) has also failed to make new highs in the last couple of weeks and global stocks have lagged (EFA).  Could it be that weaker makes for stronger?  As long as we're seeing deflationary forces at work, the Fed is likely to maintain a dovish stance.