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!

7 comments:

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.

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?

Ellen 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?

Ellen 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.

Ellen said...

http://finance.yahoo.com/q/hp?s=%5EVXO

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.

Ellen said...

Costas,

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

Here are 2 more of Conor's VIX studies:

http://www.allbusiness.com/periodicals/article/222341-1.html
http://www.allbusiness.com/periodicals/article/295549-1.html

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%.

-Mike