VXO Stretch Now So Extreme It Is Suggesting A Pullback

In last Wednesday’s blog I showed a study that the quick move from overbought to oversold in the VIX appeared suggestive of further upside.

But now we find ourselves in a situation where the VXO got extremely stretched has remained so for three days in a row. I decided to take a look at other times where this kind of extended stretch had occurred.

The numbers here appear to strongly suggest a short-term downside edge. More detailed analysis was done on the instances in last night’s subscriber letter. That analysis also supported the case for a short-term pullback.

To take a trial of Quantifiable Edges and see last night’s detailed version of this study, click here to take a free 1-week trial.

When The VIX Moves From Overbought to Oversold in a Week

The sharp drop in the market and then subsequent sharp rebound was accompanied by strong VIX movements in the opposite directions. Moving from a position where the VIX is stretched above the 10ma to one where it is stretched below the 10ma in a short period of time is quite rare. It is something I last showed on the blog on 10/9/09. I have updated that study below.

Results over the first 2-3 days are somewhat sketchy, but once you get out beyond that they become more consistent and more powerful. Since it is commonly thought that VIX stretches below the 10ma of this magnitude suggest short-term bearish inclinations for the SPX, many people may find these results surprising. This study from 2008 demonstrates that a low VIX does NOT suggest a bearish edge. And the market conditions that create this situation (SPX posts a strong rebound from a sharp decline during a long-term uptrend) don’t scream downside edge either.

CBI Reaches 10 for 1st Time Since July 2010 - Signals a Bounce

Despite the market move higher on Thursday the Quantifiable Edges Capitulative Breadth Indicator (CBI) rose up to 10.  The CBI is basically a measure of the number of capitulative selling triggers that are active among S&P 100 stocks at any one time.  Ten is a level I have discussed numerous times in the past.  Readings this high often lead to short-term rallies.  Below is a strrategy I've shown before that utiilizes the CBI.  It looks at entering the SPX when it reaches 10 or higher and then exiting when it returns to 3 or lower.

As you can see, results here are very good.  It isn't an exact timing tool, though.  The average, runup and average drawdown are both about 3.5%.  So there is has been quite a bit of volatility associated with these setups.  The average trade takes 8 days to complete.

A detailed description of the CBI may be found here.

Numerous studies and posts associated with the CBI may be found here.

If you would like to be updated on CBI readings you may follow me on Twitter.

From Fear to Excitement Overnight

Yesterday's action was marked by fear as evidenced by the 20% spike in the VIX.  This morning the SPY is gapping up 1.5%.  Here's a quick look at other instances where extreme fear turned to extreme euphoria while the NYSE was closed.

Too few instances to base any solid conclusions on.  Perhaps some indication from the early returns that the market has a chance to rally today...

A SPY Gap & Partial Fill Pattern Suggesting More Upside

In last night's letter I reviewed a large number of studies that suggested a bounce is likely to ensue in the next few days.  Below is one example.

Results here are strong, but the edge is pretty much exhausted after just 2 days.  This is not a long-term setup.

2% Gaps Down & Other Disasters

It can be difficult to know whether a very strong reaction is an overreaction. It can sometimes help to compare it to similar moves in the past. The table below is one I last showed in the 2/2/2009 blog. It looks at  all the times the SPY gapped down at least 2% to start the day. The column on the right shows how long it took for SPY to close above its gap down open (up to a week). Today I’ve also added some red arrows. These mark the other times the gap down occurred following a close above the 200ma.  As you'll note, a 2% gap in an uptrend is quite unusual.

And for those wondering about event comparisons that is a VERY difficult thing to do. Two events I looked at last night were the 1995 Kobe earthquake in Japan and the 1986 Chernobyl nuclear disaster in the Ukraine. While their local markets were hurt badly, neither event caused much reaction in the U.S. They were essentially 3-5 day pullbacks totaling between 2% and 3.5% in the SPX.


God bless the people in Japan and the Mideast.

Reminder: Fed Day Tomorrow

A quick reminder that tomorrow is a Fed Day.  I have written a lot about edges that occur on and around Fed Days.  A good amount of information can be had by clicking the "Fed Study" label on the right hand side of the blog.  (Or the link below.)

http://quantifiableedges.blogspot.com/search/label/Fed%20Study


And of course much more information can be found in the "Quantifiable Edges Guide to Fed Days" ebook and book.

Op-ex Returns By Month

About a year ago I showed a table on the blog that broke down op-ex week by month. Op-ex week in general is normally pretty bullish. March, April, and December it has been especially so. S&P 500 options began trading in mid-1983. The table below is an updated version of the one I produced last year. It goes back to 1984. I excluded op-ex week of September 2001 due to the extreme (and horrific) circumstances.

While December has been more reliable, total gains have been the largest during March op-ex.

Triangle Breakdowns in a Long-Term Uptrend

About three years ago I did a post on triangle formations. I looked at success rates and profit potential of playing breakout of them. You may view those previous findings here. Last night in the subscriber letter I took a new look at these formations and what a break (like we saw yesterday) might mean.


For coding purposes I simply defined a triangle as a pattern where the most recent swing high was lower than the previous swing high, and the most recent swing low was higher than the previous swing low, and the market was currently between those two points. This admittedly isn't the most sophisticated description, and some market technicians might suggest additional nuances should be included. Still, it seemed to be enough to identify the basic pattern of a tightening range.


I set the entry parameter to be a break above the most recent swing high or below the most recent swing low. Here it could certainly be argued that a trend line break might be more effective. I personally don't believe it would make a whole lot of difference.


Once entered the strategy was designed to exit when price either reached its target or its stop area. To calculate the target price I simply took the height of the triangle and extended that past the entry point. The stop was set at the opposing swing high or swing low that would have triggered an entry in the opposite direction had the triangle broken the other way. No trailing stops or other trade management techniques were incorporated.


Results in general were much like those results I discussed 3 years ago. I did break it down a number of different ways, though. One interesting set of results came from looking at triangle breakdowns in the SPX when it was in a long-term uptrend. Those results can be seen below.

Entries and exits are as I described above. So in this case the results show the performance of shorting a breakdown. As you can see there has been an strong tendency for this trade to reverse back up and be stopped out before reaching its downside target.


More information on triangles can be found in last night’s letter. Subscribers are also being provided with the code so that they may explore triangle formations more on their own. If you’d like to read Thursday’s letter just click here to register for a free trial.

SPY 1% Gap Down From A Tight Consolidation

A quick test I ran this morning...(results based on $100k/trade)

With only 3 instances I wouldn't get too worked up.  I did find results interesting eough to share, though.

This Pattern Has Frequently Preceded A Pop In The SPX

The market has been stuck in a trading range for the last couple of weeks, and that range has tightened even further in the last week.  Looking at the SPX we have now seen 5 closes in a row that have occurred within the range of the 3/1/11 bar.  Inspired by some gap-related research by Scott Andrews over at Master the Gap using a similar setup, I decided to take a more detailed look at this set of circumstances.  What stuck out to me is that 1) the SPX has been in a long-term uptrend. 2) There was a sizable 1-day selloff. 3) The bears failed to follow through on that selloff, yet the bulls have not managed to move the SPX back out of the range either.

Over the last 22 years or so the SPX has burst higher out of this “failed selloff” and consolidation on a consistent basis.  But the implications are only bullish for a few short days.  After that there does not appear to be a decided edge for either the bulls or the bears.

Aggregator System Riding a Hot Streak

The Aggregator has been a terrific tool that has helped me greatly in both my index swing trading and for establishing a market bias for other trades.

The Aggregator System is based on the Aggregator and it calls for a position of 100% long, 100% short, or 100% cash. For my own trading I will often scale in and out of positions depending on factors such as the strength of the evidence, perceived risk, recent market volatility, the underlying trend, my intermediate-term outlook, and more. Still, the Aggregator System can be (and is) traded mechanically. After two stellar years (2008 and 2009) it hit a rough patch last summer. But more recently the Aggregator System has been on fire. Below is a chart showing every entry and exit signal since around Thanksgiving.

(click chart to enlarge)

Signals occur at the close and are posted to the Quantifiable Edges Systems Page 10-15 minutes beforehand. They are accessible by all gold subscribers. The signal is also published and discussed in each night’s subscriber letter. If you’d like to check out the Aggregator System in more detail (including a complete history as well as current signals) you may do so with a free trial to Quantifiable Edges.

Trading Interview At The Trading Elite

The Trading Elite is a new site that features interviews with professional traders.  The site is run by Jared Mast.

I was honored to be one of the first traders interviewed by Jared.  The interview took place a few months ago, but it was posted when the site came on line in the last few weeks.  You may check it out at

http://www.thetradingelite.com/?p=22

There are also interviews with other traders whom I greatly respect, including Scott Andrews, Ray Barros, Dave Landry, and more.  So check out The Trading Elite. I have also added it to my blogroll.

http://www.thetradingelite.com/

Large Moves Up On The Day Before Employment

Yesterday I wondered whether a strong move up just prior to the employment report might set the market up for disappointment.  I looked at it a number of ways last night.  Below is the results of one of those tests.

Instances are low but stats are lopsided. Personally I considered these and my other results as a reason to hold through the report, rather than sell ahead of it.

POMO Stimulus Indicator Update

A few months ago I shared my POMO Stimulus Indicator. The POMO Stimulus Indicator simply measures the total volume that the Fed either pumps into or withdraws from the system through POMO activity over a running 20-day period. Indicator data is taken directly from the Fed’s POMO database. "Par accepted" is the measurement used. In the November 30th blog I showed a long-term chart with the indicator applied. At the time the indicator was readying to make new all-time highs. Below is an updated chart in which I have zoomed in just to examine the last year and a half.

(click chart to enlarge)

As you can see, POMO Stimulus levels have remained above the 2009 highs ever since moving above them in November. The indicator posted its highest reading in early February, and while the amount pumped this past 20 days is down from its peak, it is still over 35% higher than the 2009 highs. It has now remained somewhere between 30% and 50% above those 2009 highs for an extended period of time. "Don't fight the Fed" is an old market adage. The market has been responding very well to the massive amounts of stimulus the Fed has been pumping into the monetary system.  QE2 is supposed to last until around June. Traders would be well advised to keep track of POMO stimulus levels over the next several months and beyond. I believe there is ample evidence suggesting such activity is capable of providing a strong wind to the back (or the face) of the market. I personally update this chart on a weekly basis and post it in my subscriber letter.

If you're interested in seeing the upcoming schedule for POMO activity, you can find that on the Fed’s website. It's worth noting that the current schedule calls for POMO buying every day from now through March 9^th, and the schedule is set to be updated on March 10^th for the following month. In other words, no slowdown yet.