Volatility Interpretation

Volatility is a tricky asset class.  At least for me.  I’m sure quantitative methodologies utilizing various derivatives make it easier for the more mathematically inclined, but I do with what I got.  Chart interpretation is definitely more art than science, and I wanted to share what could be a set-up for a short-term burst in risk-off sentiment.

VIX Weekly (8-31-2021)

We’re only two weeks removed from that spike in fear that got everyone’s under-garments in a bunch.  Since April, the last 4 times the VIX spiked up resulted in intra-week advances but never closing a week above that top channel line.

Price action across all markets says to me that there is a lot of FOMO and confusion, as evidenced by declining or negative breadth and sentiment readings with new highs across various asset classes.

In order for a proper selloff across multiple asset classes, I’d like to see the VIX close out the week above 20.  Not a bear here.  Just positioned accordingly for some short-term profit should things soon get a little sparky for a minute.

Look For The Wick

I have come to utilize charting techniques less and less as their ability to help handicap asset price movements continues to wither away.

You’re either trading algorithmically in front of the market or you’re a trading loser.  Every single chart pattern and set of indicators in every conceivable combination has already been mathematically expressed by people smarter than technical analysts, and easy profits have been completely arbitraged out of the market from visual chart cues.

There will always be pockets of sheer luck.  There are always exceptions.  But earning consistent profits on price/indicator pictures…get real.

I have come to rely more and more on fundamental analysis, experience (see “gut”), and semi-quantitative tools to manage the risks of trading capital.  Like a degenerate heroine addict, I still chart.  I’ll never give it up, but it’s just another input.  Mostly noise.  Sometimes valued signal.

Despite all that, here’s one visual cue I think a lot of professionals are probably waiting for and that is a second long-stem on the S&P 500.  It could potentially indicate that risk appetites have returned.  If the HFTs see this then we could see a “schooling” move upward, like fish or a flock of birds, as the programs feed on each other’s momentum calls.

Take a look to better understand.  We are looking for a 2% to 3% wick below the weekly closing price.  That’s it.

Everybody's Waiting for a Stem - SPX (3-28-2018)

That might be all it takes to re-engage risk taking.  Not without increased volatility, of course, because liquidity is draining and conditions are tightening.

The Last Gasp

As you know by now, I think we are in the final stages of the topping process in major markets.  This is going to be a multi-month affair.  I suspect the top and crash begins later next year, but so do many other pundits, pros, and bloggers which makes me leery.  There’s nothing worse than contrarian consensus by large groups in the game of speculation.

Like its predecessors, the crash won’t look like one at first.  Sure, players will get scared and react but then we’ll see a bounce off the first initial move to the downside.  This will be an opportune time to liquidate positions to make a final cash raise to either capitalize during the crash or wait for the inevitable value opportunities that will arise.

There is a set of indicators that go along with this move downward and bounce that has proven efficacy as a guide.  It’s the 5 month and 10 month Exponential Moving Average (“EMA”).  Observe.

SPX - 5 & 10 Crossover (10-10-2016)

These aren’t magic indicators.  I’m not saying they are guaranteed to work.  I’m only saying they’ve proven themselves as guides when a real bear move has begun.  There are a multitude of economic and financial indicators that I also like to use along with anecdotal evidence, too.  Keeping an eye on this particular set of EMAs however can potentially keep your losses to between 10% and 15%, assuming you act.

In a bear market where there’s the potential for a halving of portfolios, I’d say 15% in losses is solid.

Volatility in the biggest asset classes will be unimaginable.  The algorithmic, high frequency trading operations in combination with central banks have broken all markets.  There will be no liquidity for the big timers when the bear begins.

HFTs are the true market makers and all algorithms are written to pull away and sell when bottoms fall out of markets.  Look at the S&P 500 in May of 2010.  That was really the first indication that markets would never liquidate in a typical fashion ever again, until HFTs are properly regulated, taxed, or removed from existence in markets.

There are plenty of examples between May of 2010 and now, but the move in the pound sterling at the start of October provides such a fine illustration.  What’s more liquid than the currency markets of the most developed and powerful Western nations?

Nothing.  And yet still we see the destructive power of HFT on any market.  Does this look normal in a power currency?

Sterling Madness (10-16-2016)

In earlier Asian trading, the intraday damage was even worse.  Observe this bit of madness.

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These moves are a product of liquidity being immediately vacuumed from the asset classes where all the largest players play.  This will happen again and again when the markets make their final turn.

You can liken it to a hull breach for an astronaut in space without a suit on.  One second astronaut HYG is floating around the lab in a jump suit, happily conducting experiments with OPM.  But OPM in high-yield instruments in a low-yield environment can be a volatile material if not handled appropriately in a proper setting and an explosion occurs breaching the hull, sucking HYG out into the liquidity-free vacuum immediately to death.

Did I say liquidity?  I meant oxygen.

You get the point.

Coming back to what a last gasp means; it means there will be a final run in risk assets to squeeze out the final profits of this bull.  Many, including myself, have called it a melt-up, but I grow weary of the term.

Please don’t be fooled by some of the ignorance being freely proffered out there that we are in the early years of a cyclical bull, similar to 1982.  We are not.  The evidence is broad, clear, deep, and obvious.  One needn’t a fancy finance degree or years managing wealth in order to see this.

The end game is here, but not before that last gasp for profits that I keep describing.  I suspect that many of the sectors that powered this bull market prior to 2016 may reassert themselves to take us home.  Why is that?

Interest rates.  Plain and simple.

Those with access to leverage at these historically low rates will borrow capital to fund buyouts and takeovers which will drive asset prices upward.  The upward move will then draw in speculators looking to hop on the trend or front-run it.  This quest for yield whether in debt, equity, or private equity i.e. IRR, will be the fuel for the last gasp up in asset prices.

Despite what I think may happen in semiconductors or social or biotech or emerging markets as risk-on gains speed, keep your eyes on the one asset class that has taken out all comers in 2016.  The Rocky Balboa asset class for the year.  You know what I’m referring to and this is even with the recent sell-off.

2016 Performance Chart (10-16-2016)

Precious metals.  You don’t have to love them or hate them.  Opinions don’t have to be binary.  Be agnostic when speculating.  Follow the trends.  Follow the money.  More importantly, follow central banking and political lunacy.

Let’s look at one more chart that potentially validates that this bull market is long in the tooth.  It depicts the times over the last 50 years when payouts to equity investors have exceeded  profits.

Total Payouts via ZH (10-11-2016)

You can ignore what is glaringly obvious or you can prepare.

Speaking of obvious, let’s begin to wrap this post up with another pithy little ditty of a quote, this time from one of the world’s great speculators.  It’s been reprinted time and again, but it’s simple yet brilliant message is timeless.

I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up.  I do nothing in the meantime.

– Jim Rogers

I haven’t touched on trading since the summer and I just wanted to share some set-ups that appear to potentially be building little piles of money in a corner waiting to be picked up.

Keep an eye on these sectors, either short or long:

Short:  sugar, energy(big 3), US dollar, and technology

Long:  grains, bouncing precious metals, and the pound sterling

Despite your opinions, never forget about counter-trend rallies, even in the face of what appears to be an unstoppable trend.

When Last We Was Trading…

…I’d shared some thoughts on trading volatility and the action of the S&P 500. I was right about the down-move in the S&P 500. I thought a small move was possible of no more than 5% and a 3% percent move down is what we got, then a continuance of the sideways consolidation. However, I was very wrong about volatility. I suspect the reason is because the trade was simply too crowded. Volatility became a trade du jour as the intense bounce that had started in February had obviously grown long in the tooth.

But crowded trades are a trading fool’s errand and my thesis was wrong. And so ended one of the greatest 6-month runs I’ve ever had in reading the tape, but now I’ll just have to start fresh on a new run of prognostications. The crowded trade of long volatility and short the S&P 500 was skewered by the “market making” bot shops. Even Mr. Bonds himself, Gundlach, came out and stated during a Reuters interview that from the 20th of May and on the action in the stock markets felt like a short squeeze. JPM backed that assessment as one of the largest broker dealers out there. Observe a chart they released verifying the quick spike at the end of May in short covering.

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As this short-covering burst has squeezed a chunk of the volatility hedging, too, we still very well may get a correction of 5%ish down to just below 2,000 on the S&P 500. Volatility is still worth watching for a quick scalp if enough weak hands have been washed out and the robots let some negative momentum push the S&P 500 down and volatility up.

Let’s return to the soft commodities market as sugar has just been on a silly tear. Observe:

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Just look at the last week, specifically. Talk about momentum ignition. The Commercial Hedgers have gone supremely short but this softy keeps ripping higher, moving 16% in the last week. Crazy. But the last two trading days look suspiciously like blow-offs. Have a look at what’s happened during the last two blow-offs in sugar over the past 9 months.

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You can see that prior to each of the blow-offs there were frenzied gains in very short time periods, but then astute traders could have made a nice rip quickly shorting sugar for 2 to 4 weeks. Has another opportunity presented itself for one of those rips? It sure looks like it. Go elsewhere for your farm reports, international weather patterns, crop output, regional flood potential, yada, yada, yada. This is straight up tape reading.

Using the futures proxy ETF of SGG, it is clear to see that $36 is an important number for sugar. Magnetic almost.

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Using Fibonacci from the August 2015 low to the current June high, $36 also happens to be the 38.2% retracement point on the weekly chart. Tread lightly, if you’re inclined, as the action in sugar has been fast and furious. Just look at that whipsawing action since the start of 2015. Hedge. Trade with discipline. Manage the position.

One final note from a macroeconomic standpoint, have a look at this chart of negative yield curves in Germany and Japan.

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If this doesn’t scream insanity to you then nothing can phase you. Maybe all the developed world’s central bankers have been secretly, partially lobotomized. A little frontal lobe here, a little hippocampus there, and you have a compliant banker with the inability to remember what negative rates actually mean and the lack of cognition to act effectively. Germany and Japan combined equal approximately two-thirds of the US economy. Which means their economies matter. A lot. Germany has negative yields out to a decade and Japan out to 14 years, just screaming recession is near if not already present in those two countries. You think the US is in better shape economically because we don’t have negative yields? These are different and unique times, folks. The kind of times that are remembered with head shaking and derisive snorts by future students of the economic past. Trade smart. Build cash. Stay disciplined. New highs are coming, but new lows are closer than you think.

Volatility and Price Action

On March 13th, I made a call that I thought it was time for the markets to begin consolidating. Now some may label that call incorrect as the markets have moved a couple of percent higher, even surpassing 2,100 at one point, but I stand by the call. I think late-comers to the rally pushed the S&P 500 that 2% higher.

Specifically, I guessed we’d “see about 7 weeks of sideways consolidation.” Well in order to get a sideways move, the market will need to see a little correction soon. I suspect we’ll get one starting this week. It wouldn’t surprise me to see a move downward of about 5% in the S&P 500 to the 2,000 – 1,975 area over the course of this week and possibly the next. That stem created last week on a weekly chart is the tell.

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But here’s the thing. I think market participants will completely overreact to the 5% or any move downward. I think the bears will start beating on their keyboards and cranking out articles and blog posts saying things like, “See! I told you! Here comes the real start of a 50% correction!” Pay these cranks no mind.

Instead, utilize the negative sentiment to leverage a potential move in volatility. I could see the VIX spiking to 20 in an over-reaction by hedgers. Those same late-comers to the rally in February will overdue it with VIX options potentially causing a spike.

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So how do you leverage the potential? As usual, if you’re a futures player then just structure your option strategy to take advantage of the fear. For the ETF traders and retail guy trying to swing trade some profits off his work salary, there’s the ProShares Ultra VIX ETF, UVXY. Now this ETF is a trading tool only and it’s not for the faint of heart. If you’re going to trade it then you have to be nimble and ready to take profits. The moves are sudden and quick, but profits can be spectacular if you accurately time an upward thrust.

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You can see in the last two moves of late summer last year and the start of this year, that perfectly timed trades have huge potential. In a 3 week run last August, UVXY moved up almost 300%. From late December to February, it moved up 150% in just 6 weeks. Again, not for the undisciplined. If this puppy isn’t played right, it’s easy to get shell-shocked and lose any profit potential.

Are these calls bold? Maybe, in that I don’t have any quantitative analysis to back my assessment. It’s just the gut feel I’m getting from price action and general sentiment. It can be dangerous to trust someone else’s instincts, let alone your own. A trade like this requires precision and a hawk-like watch over the action. Trading volatility can very often turn into a sucker’s bet. Let price action as opposed to greed guide your moves.