Thursday, June 01, 2006

Watching for the Reversal

The strength in the market is exciting. Crazy to hear a bear say that? Nahhhh - this whole thing has been predictable. I'm delighted we had such a strong day today. I won't be delighted if we have a few more like it!

Looking at the $VIX, it seems that the fear has swiftly become wrung out of the market as things have shored up nicely for our friends the bulls:

Looking at the index charts, I see each and every one of them approaching clean retracement/pullback levels. Here's the NASDAQ Composite as it marches back to the underbelly of its broken trendline:

The Dow 30 is in the process of making a handsome head & shoulders pattern. If you're a bear, you do not want to see it move higher than the area I've circled.

The NASDAQ 100 has farther to go than most other indexes, perhaps because it's been especially weak. If this whole affair is simply a retracement, we may not see this index reach back to its former support level before resuming its fall.

The S&P 500 is making its way up toward its median line within a very clean channel pattern:

Finally, the Dow Transports also stands a good chance of making a head & shoulders pattern. Although it wouldn't take much strength for it to render this pattern invalid.

Readership is this blog has been growing steadily each day, and I want to again express how humbled I am that it's become so popular. Thanks for taking the time!


John Wheatcroft said...

Once again the vix is in overbought territory so I wouldn't be surprised to see a down day tomorrow. Nothing new in see saw land. I'll make money by selling the shares I bought yesterday at the lows of the day. Don't know about the rest of you who are waiting for some magical turning point.

cristri25 said...

those jobs numbers are key .... they will cause a reaction.

cristri25 said...

if the jobs number comes in weak this market could spike up to dow 11,500 area ... at that point I will load up the puts !

costas1966 said...

Thos bounce will last longer and it can frustrate a lot of shorts. I think it can last anywhere from 4 to 6 weeks, we are in one week already. The right shoulder on the Dow does not necessarily has to be lower that the left, even if it goes a little higher it is fine.
On the S&Ps we are now 40 point off the lows that is 3.2% in one week. I think the market will get more choppy now and the gains will not be that fast, but they can still stretch this up to 1295-1297. Mike Stone said that the VIX hit as high as it did on 9/11. That is wrong the VIX on 9/11 was 57 compared with the 20 it hit last week, so there is still plenty of downside before the VIX gets to extreme levels.

costas1966 said...

Also I forgot to mention that we hit a monster Tick today 1449 that is the higher tick in 3 years that tells me we have probably seen the strongest day of this bounce.

Tim Knight said...

I think Mike Stone was saying that the volatility OF the volatility was as high as 9/11. Mike, how are you computing this?

cristri25 said...

what is this tick ?

cristri25 said...

aghh, i found the tick indicator , never really used it ....

Mike Stone said...

I've traded leaps before but never held them for a very long time. This time I'm thinking it's best to keep them until at least October for the seasonal low.
QQQQ & DIA seem to be the best priced.

Talking to a friend he told me that in the money is the best way to go because of time decay. But I don't get that - if the market corrects 25% DIA falls under $100.
Buying December puts at 100-105 will probably be close to $1 very soon. Seems like out of the money is the way to go & you're looking at a 5x increase.

How does time decay eat away your profits if you're holding into October?

What do you guys think?

Mike Stone said...

1) The highest high of the last two days divided by the lowest low of the last two days. About last week it yielded 1.39 which is very rare. It means the market
is going to whipsaw.

2) The triple spike in VIX (5/22, 5/24 & 5/30) are also bullish indicators for the market.

This is all short term, I don't see the bounces lasting very long. I'll probably unwind my QQQHN calls next week. I look at the chart in 2000 as a sanity check. The SPX peaked at 1550, fell a few hundred and then came back to 1520 by the end of summer. Perhaps we're in for the same?

BTW, I believe the above two VIX indicators were developed by Laurence Connors. He rightly points out to use the VIX succesfully only look at the numbers relative to the time period the VIX is in. So a reading of 50 on 9/11 could be just as bad as a reading of 20 last week because it's all relative to the volatility of the time period we're in.

costas1966 said...

My mistake I reread his post and saw that he mentioned the volatility of the vix. I would be interested in the calculation of that as well. Mike also if you can tell us how the volatility of the Vix compares to the July 2002, October 2002 the October 1998 and April 2000 bottoms. Thanx.

Mike Stone said...

Divide the high of 19 on 5/24 by 13.99 on 5/25 and you get 1.39. This is a pretty high ratio.

10/1998 - had readings over 1.4 for about 1 month
4/2000 - had readings over 1.4
7/2002 - had readings over 1.4
10/2002 - reading at 1.5

So from all these points there was a rally. Right? Connors has a book on VIX reversals. If it wasn't Connors who did this I think it was a technique I read about on Silicon Investor a few years ago. Backtested to be about 80% predicting a rally.

Big Jay said...

Tim I come to this blog practically every day. You're in my favorites. But since I am still learning, I usually just watch, chart, and practice trading on my own. But I just wanted to say that I love this blog. Keep it up.

costas1966 said...

Mike, Thanx for the formula I can now calculate those numbers I requested, unless you have a program that does that automatically, or a chart.

As for puts on the DIA I like the DEC 120's trading for 8.20. They sell only like 60 cents premium and they have a very high delta, if the dia moves down $1 they move 80-90 cents. All you need for those puts to break even considering the slipage is for the Dow to move 90 points down by October. If by October the Dow is at 9500 then you triple your money, if it is at the same level you only lose 30-50 cents about 3.5%-5.5%, if it goes up to 12000 your calls will be worth like $2.50 a 70% loss.

Now the 100s have a 25% delta, for one dolar move you get 25 cents. All you need is the Dow to move down 660 points by October to break even considering slipage. If the Dow goes to 95 they will be worth 5.2-5.3 that will be 4 times your money. If it stays the same you will lose about 50% of your investment if it goes to 12,000 you lose 90% of your investment.

On a risk reward basis with the scenarios I gave the in the money puts are the best bet. With those calls the probability of losing money is much less Now if the DOW goes below 9500,lets say it goes to 9000 then you make a killing with the 100s close to 10 times your money. Basically it is up to your risk tolerance. You need to ask youself how lucky you are.

PB said...

Can someone please explain to me why 'bad' economic numbers are good for the stock markets? I mean you gotta be sniffing some very good glue to think that they are good beacuse then the fed will stop. What fukked up thinking! Wouldn't weak numbers speak of a weak economy? And how is a weak economy good for the markets! I think this is further evidence that the past few years with low volatility are an abberation, and they will be corrected. When? I wish I knew. But this market is so stretched, that it can snap very easily. I am looking for the DOW to break convincingly below 11K to give the bears the upside.

cristri25 said...

could very well break 11k next week.
the bounce this week was weak to say the least. test the lows and then maybe as suggest grind higher before the next leg down.

Mike Stone said...


I have it programmed into Fasttrack (trading software). If you wanted to - you could download the data from into Excel and create a formula to track it automatically.

Here are 2 more of Conor's VIX studies:

Thanks for the info on the puts. I'm gonna take a gamble and go out of the money. With interest rates hiking, global currencies fluctuating, the threat of war, the threat of impachement, global stock markets falling flat on their faces, hedge funds blowing up (we've had 300+ go under in the US this year alone), the presidential cycle and the weakened breadth I can't see how the market won't fall at least 20%.