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Markets – Macro – Stocks – Charts – Alerts

Weekend Charts: Trading the Chop

Chop_ChopIn the two weeks since outlining the bull and bear cases for stocks markets have done what they have done over the past 6 months: Chop around. Indeed the $SPX on Friday closed barely 1% lower from where it closed 2 weeks ago despite seeing new highs in the process. How to make trading progress in such an environment? In today’s segment I want to share some trading habits we’ve adopted that we have found to work extremely well for us in the current environment.

Firstly let’s review what the reality of the current environment actually is:

1. All highs are fake and all lows are fake as well and traders are getting chopped up hard in the process while investors are registering few gains or more likely losses if they are diversified. Diversification in fact is probably the death knell for most portfolios and largely explains why most hedge funds have been underperforming the larger market for years now: If you are diversified you are likely getting hammered somewhere which is dragging performance down. Currencies, commodities, bonds, international stocks all have been highly volatile while US indexes seem to have been immune to any large swings.

Take the $DJIA. On Friday it closed basically where it peaked last December:

DJIA

Again. In fact the $DJIA has recently been in its tightest range of the past 115 years.

Yet while some select stocks are doing well, most in fact are not as recent highs have come on fewer and fewer stocks above their 200MA:

200 AR

High/lows have been weakening:

HLS

And the $BPSPX showed a complete lack of confirmation of recent highs:

BPSPX

So unless investor portfolios are perfectly sprinkled with only winning stocks chances are they’re not really registering a lot of gains so far this year.

2. The winners in this environment: Flexible traders that are disciplined and very selective about their entries. If one is stubborn in view of direction, whether bullish or bearish, one will have underperformed in this environment. Take a view of the $SPX since the April 27 highs. It simply has not been a swing trade environment:

SPX RM

People buying breakouts or selling breakdowns have been punished hard as markets have not followed through in either direction. And it is intellectually grinding and per the discussion 2 weeks ago solid arguments can be made for both the bullish and bearish sides. I won’t rehash them here again, but rather offer some updated charts that outline the developments since that discussion.

On the bearish side some examples:

$NYA failed its breakout:

NYA W

Small caps are sporting a potential heads and shoulders pattern:

IWM M

$XLF may have put in a double top:

XLF W

Trannies have broken a multi year trend line to the downside:

TRAN W

The $WLSH points to a breakdown of a multi year wedge:

WLSH

And all this while investors are going vertical on adding debt and negative margin to their accounts:

debt

credit

Have they lost their minds? We will know in hindsight, but it looks like an ugly combination.

Yet we see a market not breaking and therein lies the root of the bullish argument: It hasn’t broken, we haven’t had a solid high yet and the autopilot program is continuing. As should be obvious to everyone: Unless the $SPX breaks the monthly moving averages that been the stalwart of support since 2011 nothing will change as negative divergences have not mattered:

SPX M

Also supporting the bullish case: Judging by the $NYSI stocks are heading toward oversold:

NYSI W

Indeed one could make the argument that the $DJIA for example is just repeating what it did in 2014: Consolidating before the next leg higher. The structure is indeed eerily similar:

DJIA W

There still is no alternative, buybacks continue to provide buying power, channels are holding and central banks remain fully supportive of markets with no rate rises in sight as economic data keeps disappointing. In fact central bank chatter remains they single largest source of sudden price spikes.

What is my view on all this?

As it turns out the $VIX is a key chart to follow. Its upper descending trend line and lower support have been a remarkably precise turn signal for stocks:

VIX D

Friday showed another trend line rejection and a large gap remains below. This indeed could signal another move higher for stocks as $VIX gaps tend to fill eventually. But as the chart also makes clear: This pattern will come to an end in the near future. And while one can choose to believe the $VIX will break down to below 10 (which it has exactly once in its history), that very history suggests it will eventually break higher.

And hence the near term risk range we outlined 2 weeks ago remains in full effect which includes an upside price risk into the 2150-2250 zone this summer before a likely larger fall correction:

SPX D

Were markets to break down instead our in house bull Mella_TA has outlined some key technical support levels which we view as potential long swing zones on the first connect especially any move into the 1940-1970 areas were they to occur.

Mela

We can’t be dogmatic about the next big move but surely want to partake in it.

Until the next big move happens here’s the reality: The biggest moves seem to occur overnight or they happen on very fast ramps either preceded or followed by hours of tight ranges. These fast moves are completely news driven, either by a central bank driven event or headline or by a news flash which invariably proves out the be fabricated and then denied. Fake or not they create vicious price action.

Take Friday’s latest example: Another bogus Greek news flash and guess who got really excited about it? Ironically the Russell ($TF):

TF

Another vertical V following another steep drop. The Greece headline that sparked the short covering came within minutes of a miserable close in Europe. As I said at the outset all highs are fake all lows are fake and only the most flexible traders can do well in this environment. Which brings me back to trading habits in this environment.

Here’s what I told our members on Friday:

T1

Why stupid? Because algos are running stops in either direction and end up exaggerating price. It creates a price vacuum and patient, but determined traders can take advantage of it by fading the vacuum.

Now how to fade such a price spike and not get run over? Here’s are steps that work for me:

1. The more vertical the up or down move the higher the risk/reward for a fade

2. I wait for hesitation/reversal at a price level of identified resistance/support/trend line.

3. I place the trade with a defined stop. Stop losses are fine as they are there to protect you. Yet algos like to find stops and take them out hence the exaggerated price movement in the first place. Yet they do run out of gas and once stops are taken out they create the point of opportunity.

4. I wait for price to move in my favor to then adjust the stop to flat thereby minimizing risk. I mostly use futures on such a trade to minimize commission expense.

5. If I get stopped I may try again especially if we see a retest of price and rejection.

6. Then once price moves in favor of the trade I scale out position sizing at the next levels of support/resistance until the trade is completed and I may flip in the opposite direction.

7. Rinse and repeat.

In the case of the $TF spike on Friday it created the appearance that buyers knew something. It was an algo driven stop run and we faded it on Friday:

T6

Did buyers know something? They didn’t:

TF2

I won’t tell you that these are easy trades. They are not and besides technical signals I’m relying heavily on my years of experience of reading the tape adjusted for the current environment. The other issue: We are humans and can’t be glued in front of our screens 24/7. Who wants to be anyways? Hence one must accept that certain moves will be missed and that’s ok. The key is to remain patient and wait for the set-up to emerge and then react decisively under the following premise: Do no harm, stay tight on stops and don’t get your psyche worn down by the chop, but find ways to take advantage of it.

For more information about our trade philosophy or on how to become a member please visit the About and Membership pages.

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3 Responses »

  1. I think we see the SPY hit 225 before we consolidate and then move even higher. There is nothing to fuel a correction at this point since pension funds who bought, can hold on for 5-10 years if needed, as long as the SPY pays a dividend greater than 0%

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