Monday, August 17, 2015

Trading Notes: Week of 8/17/2015

Friday, August 21st

*  It was a second straight day of very weak volume flows; the failure to sustain bounces was evident relatively early in the day and quite telling, as the range market gave way to a trending trade.  Stocks making fresh new lows expanded and almost 600 NYSE issues closed below their lower Bollinger Bands.  Interestingly, when that has happened in the past year, there has tended to be further downside over the next five trading days.  We are very stretched to the downside short-term, with fewer than 10% of SPX stocks trading above their three and five-day moving averages.  With VIX at 19, I expect more volatile moves and the possibility of stiff short-covering moves.

*  My next day and 3-5 day models have turned moderately bullish, reflecting the short-term oversold condition.  Intermediate term measures are not at levels that we've recently seen at intermediate-term lows.  I will be watching the quality of bounces from the oversold level closely; if weak, I would expect further downside.  My game plan is to wait for those bounces before reinstituting shorts.  I'm also open to short-term buying of weakness that fails to make fresh price lows.

*  Pure volatility is quite high, which means that each unit of volume produces significantly more price movement than it did at recent market peaks.  With expanded volatility, moves can extend further than we would expect--very relevant to risk management.

Thursday, August 20th

*  Volume flows were weak through the day, confirming the bearish expectations of the models and the downside stock trade in the wake of commodity/China weakness.  This weakness has carried forward to premarket trade.  Short term indicators are at levels stretched to the downside, but intermediate-term ones are not.  For example, about 17% of SPX shares are trading above their 3-day moving averages.  That creates an environment ripe for a counter-trend bounce.

*  The possibility of counter-trend bounce is also heightened by the fact that one of my 3-5 day models is flashing a bullish signal, the first in quite a few days.  Should we see weakness in today's session not confirmed by volume flows and breadth, I would be willing to participate on the long side for a short-term trade.  

*  Pure volatility measure is elevated, also highlighting possibility of near-term bounce and VIX closed above 15.  Neither are at levels associated with intermediate-term bottoms, but I do expect to see more volatile trade going forward, which has implications for sizing, stops, and targets.

Wednesday, August 19th

*  Whereas Monday's market could not sustain selling pressure--the number of downticks across stocks was modest--Tuesday was the reverse, with limited buying.  The volume flow measure was solidly negative on the day, and we could not take out the overnight highs.  This tape action fit well with the bearish model signals from yesterday, and we're seeing further price weakness in premarket today.  I continue to doubt a sustained upside for stocks as long as we see continued commodity weakness, which speaks to global economic weakness, especially in EM.

*  We can see breadth weakness in the number of stocks persistently trading under their lower Bollinger Bands versus those trading above (see below; raw data via Stock Charts).  Note how the divergence in the cumulative Bollinger balance preceded the drop in October of 2014.  We are currently seeing quite a massive divergence; there are simply more stocks across the NYSE universe trading with significant weakness than with significant strength.

*  Next day and 3-5 day models are neutral, and we continue to work on the bearish swing signal from yesterday.  Game plan is to continue to sell bounces that cannot exceed the overnight highs and monitor volume flows, particularly should we test support in the ES 2070s area.  Downside action without expansion of downside tape action has been a good short term signal for profit taking on the short side. 

Tuesday, August 18th

*  We had an impressive rally once we held Friday's lows in the ES.  My volume flow measure only got as low as -250 early in the morning, compared with values well below -1000 when we've hit truly oversold levels.  That was a sign that, like Friday, we just were not seeing aggressiveness among sellers.  The ensuing rally has turned my next day model very modestly bearish and the 3-5 day models have turned bearish.  We are at levels of pure volatility that have been associated with weak next 3-5 day returns.  My game plan is to short bounces that stay below the recent highs.  On a swing basis, I am alert for indications of more aggressive selling that would take us below the recent support in the 2070s.  That being said, I'm also watching XLE and XLB carefully for any indications we could be bottoming in the commodity-related sectors.  That would offer important support to stocks on any pull back.

*  My next research project will be to track volume flows in the premarket and also at end of day, including the after market.  It is not clear to me how the flows in these time periods might be related to those in the next period, but there are meaningful flows, especially end of day, that could offer clues as to the next day's trade.

Monday, August 17th

This article goes into depth about what I believe to be the greatest performance problem affecting traders. I see a real mismatch between how traders think about opportunity and how they actually manage their positions. It's too glib to simply attribute this to "lack of discipline" or failure to follow plans/process.  Quite literally, traders become caught between two imperatives and the inability to reconcile those results in the quandary where we plan trades but don't trade those plans.

*  We've been seeing a decline in stocks making fresh new highs for the past several months (see chart above), but we've also seen a drying up of new lows during the rangebound trade.  My next day and 3-5 day models are very modestly bearish and several of my measures are moderately overbought and in ranges where we typically see weakness.  My game plan is selling strength that fails to take out overnight highs.

*  Friday's trade saw a distinct drying up of downside volume flows, followed by consistent though moderate buying flows.  Flows exceeding Friday levels on either side would strike me as significant in establishing direction for early trade this week.  When you see concerted hitting of bids or lifting of offers across the stocks trading the highest volume, you know that major market participants are putting capital to work.  That wasn't happening on Friday, as SPY volume was at very low levels.  Need to see evidence of meaningful volume flows before assuming any breakout from the recent pattern of declining new lows and new highs.