Monday, March 21, 2016

Trading Notes for the Week of March 21, 2016

Friday, March 25th

*  Perhaps the most common psychological challenge I hear from traders is how to keep a positive mindset during periods of drawdown.  It's very difficult to lose money for a stretch of time when you're pouring your heart and best efforts into markets.  But there is no surer way of missing opportunities than becoming self-focused and negatively focused.  This recent article focuses on how we can sustain well-being and a positive mindset even when everything seems to be going wrong.

*  Stocks bounced from their short-term oversold situation noted yesterday with the swing overbought/oversold measure. I am watching breadth closely here, as it would not surprise me to see a more selective phase of the market cycle going forward.  The relative performance of small caps is of particular interest. 

*  I'm seeing increasing talk of direct monetary stimulus to economies.  I suspect this will be actively considered if we get a renewed deterioration of financial conditions and concerns re: deflation.  The implications for asset prices (weak currencies, strong commodities) would be significant.

*  I've been putting considerable work into a set of swing measures that track overbought/oversold conditions and volatility.  These are based on event time, where each bar represents an amount of volume or price movement in the market, not a unit of chronological time.  The OBOS measure captures momentum and value effects on a swing basis:  swing returns in ES have been best when we're significantly overbought (+.54%) and significantly oversold (+.49%).  Returns have been subnormal between these extremes (-.05%).  Although I need to keep the specifics of the measure proprietary and limited to the managers I work with, I'll happily update periodically on this blog.  Swing returns from current levels of OBOS and vol have not been significantly positive or negative.

*  Here is a swing volatility measure that looks at the volatility of the event bars.  Note how we're near levels that have recently corresponded to market peaks.  This is yet another reason I'm watching breadth closely.

Thursday, March 24th

*  Thanks to Aaron Fifield for interviewing me for the Chat With Traders podcast.  We touch on a number of topics relevant to factors that make for trading success.  He's assembled an excellent lineup of interviews worth checking out.

*  We've seen a recent pullback in stocks and oil; yesterday's close saw an expanded number of stocks making new lows amidst relative weakness among small caps.  I will be tracking breadth closely here, as we might be seeing a more selective phase of the recent market strength.  Below is a chart of stocks across all exchanges making fresh 3-month highs vs. lows:

*  I've been exploring a swing overbought/oversold measure based on event bars.  As you can see, we've recently entered oversold territory.  As long as these swing lows are occurring at successive price highs, I'm willing to give the benefit of the doubt to the bulls.  The chart tracks the measure through the recent move higher.

Wednesday, March 23rd

*  We saw an early selloff due to the Brussels news, but this was bought relatively early in the NY session.  It's a good example of how, in a momentum environment, participants want to get long even on relatively modest dips.  That being said, my breadth volatility measures (volatility of daily breadth numbers) has been coming down and that has led to subnormal returns over the near-term horizon.

*  Interestingly, we're hovering near our highs, but yesterday saw only about 40% of SPX stocks trading above their 3-day moving averages.  During these momentum periods, corrections tend to be rotational and we're seeing some of that.  Housing, financials, consumer staples, utilities--all have been off their highs recently.  Technology has been stronger.

*  My cycle measure continues in elevated territory, again unlike much of what we saw in 2015, where strength led to weakness.  That continued elevation on a shorter-term cycle measure suggests that a longer-term cycle is at play and that this has been more than a bounce in a bear market.

Tuesday, March 22nd

*  We're seeing some consolidation overnight following a modest up day yesterday.  While SPX closed higher, we returned to underperformance of small caps and the number of stocks across all exchanges making new monthly highs dropped from 1660 to 886.  New monthly lows also dropped, however, as we're still not seeing distinctive weakness in any sector.  Volume and volatility dropped; VIX is now below 14.  More on volatility below.

*  Below is a short-term measure of the number of SPX stocks making fresh 5, 20, and 100-day highs versus lows.  Notice how we have stayed elevated for a number of consecutive days and how this is different from what we saw through much of 2015.  Whereas "overbought" readings were opportunities to sell last year, so far in this rise we're seeing momentum and strength leading to further strength--one of the signature characteristics of a fresh market cycle.

*  Despite the market's strength and momentum, the rally has not had a lot of fans.  I notice on the Stock Twits site, for example, that messages regarding SPY are 40% bullish, 60% bearish.  That ratio hasn't changed much during the last two weeks of gains.  I also notice that shares outstanding for the SPY ETF have once again dipped, now dropping below their levels from 5, 10, and 20 days ago.  Very interestingly, the number of shares outstanding for SPY has dropped over the course of the rally from mid-February.  Share redemption has generally been associated with superior returns over a multi-week horizon.

*  As mentioned above, volatility has dropped over the course of this market rally.  Equally notably, my pure volatility measure (volatility per unit of trading volume for the ES futures) has dropped significantly (see below) and is getting to levels that have been seen at recent market highs.  I am very open to the possibility that we're going into a different phase of the market cycle where we'll see lower volume, less movement per unit of volume, and more of a grinding trade.  For traders accustomed to the movement that we saw for the first couple of months of this year, that transition to a low vol regime can be challenging, requiring a fresh approach to setting targets, stops, and holding periods.

Monday, March 21st

*  So often, in our trading goals, it's set and forget.  We set goals, but often fail to follow through.  This article draws upon recent research to identify how can we become more productive--better at pursuing and reaching the goals that we define.

*  Stocks closed higher overall on Friday, and we're now seeing over 90% of SPX shares trading above their 20- and 50-day moving averages.  That is unusual strength off the February lows.  My measure of upticks versus downticks among NYSE stocks (NYSE TICK) showed solid strength on Fed day and, as the chart below shows, has been in an uptrend on a cumulative basis, eclipsing its previous high.  I believe we're pricing in a more favorable environment for equities, given QE overseas and a moderating Fed.

*  Yet another way of tracking the strength and weakness of shares is to look at each stock on the NYSE and see if it has closed above or below its Bollinger Bands.  (Raw data from Stock Charts).  As the chart below shows, we have reversed the pattern of net weakness from 2015 and early 2016 and have been persistently above the zero line in recent days.  Bottom line, I'm not seeing the kind of deterioration that would normally precede a major market reversal.

*  A while back I mentioned the shares outstanding in the SPY ETF as a useful sentiment gauge and noted that it had been flashing bearish sentiment, even after the liftoff from the February lows.  Sure enough, history repeated and we continued higher.  Now we're seeing an expansion in shares outstanding (net bullish sentiment).  In the past that has led to subnormal returns for SPY.