Monday, October 05, 2015

Trading Notes: Week of October 5th

Friday, October 9th

*  Morning selling pressure yesterday could not breach overnight and prior day lows, continuing the flat correction.  In general, when overnight and prior day lows/highs hold on early day selling/buying, it's worth thinking about buying the dip/selling the bounce to exploit the potential pattern of higher lows/lower highs.  With the Fed minutes, significant buying flows once again returned to stocks and we again made new highs for this move, with an expansion in the number of shares registering fresh highs.  A total of 242 SPX stocks registered fresh 20-day highs vs. lows, the highest since August 17th (raw data from Index Indicators).  As emphasized yesterday, I'm not seeing the kinds of divergences that would normally precede a substantial correction. We're once again stretched on a multi-day basis, so that leaves me in the mode of buying pullbacks.

*  Earlier entries mentioned the very strong buying pressure during this rise.  On a five-day basis, we've seen buying strength that has only been present on 9 prior occasions since 2012.  Ten days later, SPX was up 8 times, down once for an average gain of about +3.0%.  Once again, this highlights the momentum effect once institutions dominate on the buying side.

*  Volatility continues to decline, with VIX now below 18.  If this is like past strong buying cycles, we will see modest pullbacks and further grind higher on lower volatility until breadth divergences begin to appear. 

Thursday, October 8th

*  Buying dips indeed proved to be a useful strategy in Wednesday's session, as we closed once again with strength.  Across all exchanges, we saw over 1000 stocks register fresh monthly highs, a new high for this upleg.  In general I don't become overly concerned about sustained downmoves unless we see a preceding period of time in which fewer stocks participate in the strength.  Thus far, the participation has been solid, with the buying pressure mentioned yesterday continuing strong.  We're quite extended in the short run, so the consolidation we're seeing in overnight trading is not unusual.  My leaning is to allow this consolidation to run its course before resuming long positions.  Even in healthy uptrends, it's not unusual to get a pullback in which the majority of shares trade below their 3 and 5-day moving averages.  I'd look at such a pullback as a potential buying opportunity; I'd also be interested in buying any flattish correction that stays above the 1960-ish level.

*  Note that VIX continues lower and continues to stay below 20.  I continue to hear people put the bear thesis out there, but the market is just not trading that way at present.  I believe investors see the global weakness out there and are already buying stocks in anticipation of further easing from central banks.  Traders who wait for the actual central bank announcements before buying may be making a mistake.  With Friday's weak jobs number in the U.S., an accomodative monetary policy across the globe was pretty well ensured.  Markets are forward looking.

*  Below you can see a short-term rate of change indicator (red) plotted vs. ES futures (10/2/15 to the present), where each bar represents 500 price changes in the index.  This normalizes for activity during slow periods, such as overnight.  I like the perspective as a short-term overbought/oversold measure.  In general, I like buying oversold levels when we're making higher lows and higher highs and vice versa.  I like taking profits when we get overbought/oversold and can't make new highs/lows.

Wednesday, October 7th

*  We did indeed get the consolidation noted in yesterday's post and, so far, we're seeing some holding of the consolidation and buying of the dip in overnight trading.  I'm watching to see if we can hold those overnight lows, with a leaning toward buying weakness that holds above ES 1960.  My short-term models remain modestly bearish, however, so I'm open to the possibility of further consolidation.

*  Readers will recall that I break the uptick/downtick statistics into separate measures of buying pressure and selling pressure.  The buying pressure has been very strong over the past five trading sessions.  Returns 3-5 days out have been choppy, with little edge, but 10 days out we see 15 occasions up, 2 down for an average gain of over 2%.  We'll need to see distinct selling pressure to entertain a return to a bearish regime; we'd also need to see VIX exceed 20.

*  Put/call ratios have come down quite a bit from the recent market lows.  That's another reason I wouldn't be surprised by sloppy trading near term.  I also note the upside breakouts in emerging market currencies (CEW) and commodities (DBC); both are reversals of the previous bearishness around China.

Tuesday, October 6th

Great summary of my recent podcast with Better System Trader from The Waiter's Pad; thanks, Mike!

*  We saw very good follow through to Friday's strength, as the volatility plus the buying flows (volume-weighted NYSE TICK) created significant upside momentum.  We saw 780 stocks across all exchanges make fresh one-month highs against 143 new lows.  We've come off a bit overnight and my models are moderately bearish over a 3-5 day horizon, so some consolidation is to be expected.  My sense, however, is that many traders have missed this rally and will be interested in buying dips, which could keep consolidations modest--as much in time as in price.

*  Another reason I expect some consolidation is that we're quite stretched on a short-term basis, with over  90% of SPX shares trading above their 3, 5, and 10-day moving averages.  When we've had a moderate VIX under those circumstances (between 15 and 25; N = 12 going back to 2006), the next day has been up 3 times, down 9 for an average loss of -.12%.  Indeed, 10 of the 12 occasions posted a lower close over the next two trading days.  That being said, the next 10 days have been 8 up, 4 down for an average gain of +.37%, with 10 of the 12 occasions posting a higher close within five trading days.  So not much edge in general, though my base case is to see consolidation in the next day or two that is worth buying into.

*  I mentioned yesterday that I'm keeping an eye on VIX.  We're below 20 for the first time in a while; if any consolidation does occur in a flattish fashion, reducing realized volatility, that would suggest a return to the old volatility regime and would be bullish overall for stocks.

Monday, October 5th

*  In my Forbes blog, I review one of the best market books I've read in a long time.  It's a detailed treatment of high yield markets and a great reminder of how we can learn a great deal about the markets we trade by studying and understanding related markets.

*  Friday was a day worth studying in detail.  We had a weak payrolls number and stock futures sold off hard.  We opened with selling on the day, as NYSE TICK hit several quite negative figures, but price stopped going lower and the downticks began making higher lows.  This emboldened buyers to come in, upticks swamped downticks, and we wound up with a very strong day to the upside.  That strength has continued into overnight trading, as it indeed appears that we have successfully tested the downside.  The oversold intermediate-term indicators that I referenced last week will not hit overbought levels for a while and volatility appears to be at the bull's back, so I expect an environment in which pullbacks will be bought.

*  I will be watching VIX closely here.  One idea I'm playing with is that we've entered a higher volatility regime, much as what happened in 2007 prior to the 2008 bear market.  VIX generally bottoms ahead of stock market highs and, in the current environment, that wouldn't surprise me.  That 2007 period was a rangy topping market with good swings due to the higher volatility.