MMFI Is A Key Measure of Stock Market BreadthI recently updated my piece defining oversold and overbought conditions using MMFI or the percentage of stocks trading above their 50-day moving averages (DMAs). Here is the key text from that post:
Above the 50, AT50, is overbought above 70%
Above the 50, AT50, is oversold below 20%
The Technicals of Converting from Above the 40 to Above the 50
Converting from Above the 40 to Above the 50 is relatively straightforward because the two measures are closely correlated. TradingView provides historical data back to January 2, 2002. Worden provides historical T2108 data back to 1987. The correlation over 8 1/2 years is 0.95. Over 20 years the correlation is 0.95. Thus, the relationship looks sufficiently consistent over time.
Above the 50, AT50 (MMFI) and Above the 40, AT40 (T2108) are highly correlated.
The correlation between AT50 and AT40 are highest at the extremes and worst in the middle. The correlation is better at the lower extreme than the higher extreme. Fortunately, the extremes of market breadth provide the most information for trading (overbought and oversold). The equation shown in the chart comes from the black diagonal trend line.
The linear approximation of the above scatter plot provides the new threshold values. AT50 overbought = ( – .3954) / 1.0007 = 70%. AT50 oversold = ( – .3954) / 1.0007 = 20%. So while wide variability exists in the relationship between AT50 and AT40 in the middle of the 0% to 100% range, the relationship works well at the extremes.
The Precision of the New Overbought and Oversold Thresholds
I examined the precision of the new overbought and oversold thresholds to add a layer of reassurance for this conversion.
Over the 20 years of data, the minimum value for AT50 for any AT40 overbought period is 55%. Accordingly, capturing any and all AT40 overbought periods requires triggering the overbought trading rules with AT50 above 55%. This conservative approach to eliminating false negatives for overbought provides 100% recall but poor precision. Using 100% recall would trigger overbought trading conditions 54% of the time based on the past 20 years of history. Something that happens the majority of the time is not an extreme! Thus, for trading extreme market conditions, precision is more important than recall.
The maximum possible value for AT50 for any AT40 oversold period was 42%. Even intuitively, traders can recognize that 42% is not low enough to define meaningful oversold conditions. Indeed, AT50 has traded below 42% for 25% of the trading days in the past 20 years.
Precision in Chart Form
The charts below provide a visual of these relationships. Each bar defines a “bin” which is a range of values. For example, think of the 70% bar as representative of all percentages starting with 70, like 70.1, 70.5, 70.9, 70.99, etc… The green bar marks the threshold for overbought in the first chart and oversold in the second chart. The yellow bars provide alternative thresholds based on the relatively high odds. The height of the bar represents the “odds” that AT40 is overbought (or oversold) given the value of AT50 on the x-axis. I calculated the odds as the percentage of time that AT40 is overbought (or oversold) given the value of AT50 over 20 years of data.
These charts show that the oversold trading period is more distinct than the overbought trading period relative to the AT40 definitions. Of course, if I started my work from AT50, this fuzziness would not be an issue. Regardless, traders should not treat the overbought and oversold thresholds as numbers fixed in stone. When the stock market approaches these thresholds, I use other data to identify when trading conditions are “close enough” to oversold or overbought. For oversold conditions, the volatility index (VIX) is useful. For overbought conditions, I look for signs of buying exhaustion as the stock market falls out of or away from overbought territory.
T2108
Important Breakout for Market BreadthStock Market Commentary
A meme rush pushed the stock market toward summer trading. A breakout for market breadth launched summer trading. Small cap stocks appeared to lead the way even as the S&P 500 and the NASDAQ wilted for the close of trading. The divergence still leaves the stock market poised for an eventual rendezvous with overbought trading conditions.
The Stock Market Indices
The S&P 500 (SPY) gapped up slightly to start summer trading. Sellers took over from there and pressured the index most of the rest of the way into a 0.1% close.
{The S&P 500 (SPY) gained 0.9% and stretched for an all-time high.
The S&P 500 (SPY) faded its way from May’s all-time high to a 0.1% loss.}
The NASDAQ (COMPQX) printed a sharper divergence between buyers and sellers. After the initial gap up, sellers took the tech-laden index nearly straight down for the next hour. From there, buyers were eventually able to settle on a 0.1% close for the day.
{The NASDAQ (COMPQX) gained 0.7% to end a week the strung together a series of all-time highs.
The NASDAQ (COMPQX) gapped up and then faded its way to a 0.1% loss on the day.}
The iShares Trust Russell 2000 Index ETF (IWM) led the way and helped to expand stock market breadth. Like the other major indices, sellers immediately challenged the gap up on IWM. However, after the first hour of trading, buyers managed to maintain upward pressure most of the rest of the way. IWM closed out the day with an important 1.1% gain that took the index of small caps close to the top of its trading range. I continue to keep my powder dry until I see a definitive breakout (or breakdown) from the trading range.
{The iShares Trust Russell 2000 Index ETF (IWM) led the way with a 1.1% gain and closed near the top of its trading range.}
Stock Market Volatility
The volatility index (VIX) kept me from celebrating a kind of bullish divergence on the day. Somehow, the VIX rebounded from a plunge to the April intraday low and closed with a 6.7% gain. I do not quite know what to make of this move. It should signal another sustained bottom for the VIX, but the expanded market breadth is inconsistent with this VIX revival.
{The volatility index (VIX) continues to cling to the 20 threshold.
The volatility index (VIX) bounced back from April’s intraday low to close with a 6.7% gain.}
The Short-Term Trading Call With A Breakout for Market Breadth
AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, closed the day at 58.9%. My favorite technical indicator gapped up and sliced right through a downtrend in place since January. While the highs of April look like formidable resistance, this breakout looks important. The expanding breadth looks like it includes sufficient momentum. If I am correct, then this summer should eventually feature a test of overbought trading conditions (AT40 at 70%).
{AT40 (T2108) broke out above a 5+ month downtrend to close at 58.9%.}
The path to overbought should still feature chopping and churning but now with a slight upward bias. As I stated above, the VIX is a key wildcard in this picture. I doubt the stock market can long sustain an upward bias with the VIX drifting higher. Indeed, I think a challenge of overbought conditions has to come with a bullishly fresh breakdown in the VIX. In the meantime, my short-term trading call remains comfortably at neutral until clearer trading signals emerge.
Be careful out there!
Bears Put On Notice As Stock Market Finds Fresh SupportAbove the 40 (March 11, 2019) – Bears Put On Notice As Stock Market Finds Fresh Support
March 11, 2019 by Dr. Duru
AT40 = 63.0% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 41.8% of stocks are trading above their respective 200DMAs
VIX = 14.3 (10.7% drop)
Short-term Trading Call: bearish
Stock Market Commentary
The stock market’s scramble for support worked bigtime today.
In my last Above the 40 post, I described the dilemma facing my flip from cautiously bearish to bearish for my short-term trading call. The stock market wasted no time in forcing me to stay my hand right in the middle of the rule I established to guide bearish trades: wait for a breakdown or a test of key resistance. Bears like me were clearly put on notice with today’s trading action. It looks like my next bearish trade will be at a test of resistance. If THAT resistance gives way, then I will be forced to flip neutral and watch the stock market go right back into an extended overbought trading spree.
The S&P 500 (SPY) soared 1.5% as it leaped over its 200-day moving average (DMA) in picture-perfect form.
{The S&P 500 (SPY) gained 1.5% as it reached for its last high which is now the next resistance level.}
The NASDAQ (NDX) did the S&P 500 one better by gapping up and through its 200DMA and closing with a 2.0% gain. The tech-laden index tapped the lower bound of its upper Bollinger Band (BB).
{The NASDAQ (NDX) gapped up strongly enough to put it within a day's rally of testing its last high.}
The volatility index, the VIX, underlined the rush back into the market with a 10.7% plunge well below the 15.35 pivot. The move was a perfect continuation of Friday’s fade. My only new bearish trade on the day was to triple down on my Pro Shares Ultra VIX Short-Term Futures ETF (UVXY) call option (needless to say I cycled through some other call options which are accompanying short shares!). These UVXY calls expire on Friday, so they are even more speculative than usual.
{The volatility index, the VIX, headed straight toward its recent lows in a sharp extension of the previous trading day's fade.}
AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), confirmed the rush back to “risk-on” trading by leaping from 54.1% to 63.0%. Suddenly, my favorite technical indicator is within sniffing distance of overbought levels (above 70%) all over again. In my last post, I noted how AT40’s rapid drop the previous 3-5 days generated a condition that “felt” oversold. I never even thought about trying to trade that “quasi-oversold” condition from the long side. If I had, I would have taken profits as quickly as I took last week’s profits from new bearish trades.
Now, as bears sit up straight and take notice, I will be watching to see how the S&P 500 (SPY) challenges its 2019 high, a high that was set on the first day of the month.
Stock Chart Reviews
Apple (AAPL)
My bearishness restricted my weekly play on Apple (AAPL) call options to a single call. My very optimistic profit target of a double was exceeded with a close with a triple….and AAPL was just getting started. The stock made a definitive statement with a close on its high of the day and a new 3-month high. As I like to say, it is hard to stay bearish when AAPL is in rally mode. So, AAPL has put me on notice that the S&P 500 is likely to soon, and easily, challenge its 2019 high!
{Apple (AAPL) jumped 3.5% to close at a 3-month high.}
Alphabet (GOOG)
Alphabet (GOOG) gained less than AAPL did, but the stock looks more impressive. GOOG broke out to a 5-month high and confirmed 200DMA support. The stock looks like it built a strong base from the wide consolidation underneath the 200DMA. GOOG is a buy-the-dip stock now, so it will NOT be on my list of stocks to short unless it drops below its 200DMA again.
{Alphabet (GOOG) soared 2.9% and closed at a 5-month high.}
S&P 500 Performance During Overbought and Oversold TradingS&P 500 Performance During Overbought and Oversold Trading Conditions
January 31, 2019 by Dr. Duru
Introduction
The percentage of stocks trading above important moving averages provides good information on the breadth of the stock market. I use the percentage of stocks trading above their respective 40-day moving averages (DMAs) because the historical data are readily available for analysis. I call this indicator “AT40” as a shorthand for “above the 40DMA” to clearly differentiate it from AT200 which is shorthand for “above the 200DMA.” (In TC2000 by Worden, these indicators are called T2108 and T2107, respectively). In this post, I provide my latest update on AT40 data with an emphasis on oversold (AT40 below 20%) and overbought (AT40 above 70%) trading conditions.
Market breadth provides hints about the sustainability of a market rally or sell-off. A stock market rally tends to lift all boats, but over time this rising tide wanes. Money is not infinite, so in the short-term buyers will exhaust themselves at some point. Fewer and fewer stocks attract new money until, eventually, the remaining buyers are not purchasing enough stocks to keep pushing the major indices higher, particularly the S&P 500 (SPY). This slowing momentum shows up as AT40 making little progress even if the S&P 500 continues higher. I label the most distinct changes in momentum between AT40 and the S&P 500 as “bearish divergences.” Tops can also happen when buyers exhaust themselves in one sharp and abrupt push higher which I call a “climactic top”.
On the downside, sellers push more and more stocks below their 40DMAs. At some point, sellers exhaust themselves after satisfying their desire to reduce risks and the remaining holders think stocks are priced below their true values. This slowing downside momentum shows up in AT40 making little progress to the downside even as the indices continue downward. Sometimes the bottom comes in a sudden rush of buying.
Overbought and Oversold Trading Conditions
I adopted conventions to define the AT40 thresholds for overbought as 70% and for oversold as 20%. Because these periods must end, they present unique short-term trading opportunities. There are two important questions for trading these extremes: 1) how long will the extreme last, and 2) how will the S&P 500 perform during the extreme trading conditions. The performance question has two sub-components: total performance and greatest extreme of performance whether drawdown or maximum gain.
In this post, I answer the duration and the total performance questions. All data run from September 17, 1986 to January 11, 2019. The first oversold period in this period started on October 15, 1987 (in the middle of the crash of 1987). The first overbought period started on November 5, 1986. Perhaps ominously, the stock market experienced SIX overbought periods lasting a total of 78 trading days ahead of the crash of 1987.
Based on medians and means, extremes typically last short periods. The charts below show the number of trading days on the y-axis and the percentage threshold of AT40 on the x-axis. Each chart zooms in on the range of thresholds of most interest because durations increase rapidly beyond 50% and distort the visual.
{...}
Both charts indicate that the stock market typically spends very little time beyond the AT40 extremes whether oversold (below 20%) or overbought (above 70%). Short-term traders and long-term investors should buy oversold conditions. Short-term traders should prepare to sell/short during overbought conditions and long-term investors should generally avoid buying during oversold periods. Each rule includes important caveats to accommodate the potential for extended periods of extreme trading conditions. I discuss these on my resource page. For example, during oversold periods, the most attractive buys occur buying during a sharp rise in the volatility index, the VIX. Conservative traders/investors might wait to buy until after the oversold period ends. During overbought periods, the most attractive shorts may occur after the overbought period ends or when the S&P 500 (SPY) experiences a definitive rejection at important resistance levels or a sharp rise higher and then a rush back downward.
These rules and caveats are important because, as the charts below show, the longer the stock market spends in oversold conditions, the worse the S&P 500 tends to perform. Similarly, the longer the stock market stays overbought, the better the S&P 500 tends to perform. Simple trendlines represent these relationships. The y-axis is the percentage change in the price of the S&P 500 measured from the close of the first day of the AT40 period to the close on the first day AT40 closes outside the period.
{...}
The red dots in the oversold chart indicate the most recent oversold periods. Going from left to right, they represent the oversold period from October 10 to 15, 2018 and the historic oversold periods from October 17 to 31, 2018 and December 14, 2018 to January 3, 2019. The green dots represent the two oversold periods from February, 2018. The trend lines provide a way of projecting in very approximate terms what to expect from the S&P 500 based on the duration of an oversold or overbought period.
Above the 40 Relationships
In prior posts, I have used charts that included projections from a machine learning model. I am in the middle of revising those models. Until I finish the remodeling, I will refer to the above charts and this post for describing the dynamics of a given oversold or overbought period. The most important highlights for now are: 1) the oversold (inverse) relationship between duration and S&P 500 performance is relatively well-behaved, and 2) for overbought periods, the S&P 500 performance becomes strongly biased to the upside after 23 trading days.
Above the 40 – Current Conditions (January 30, 2019)
The stock market is currently overbought with AT40 closing at a startling 81.0%.
{...}
AT40 was last this high on April 27, 2016.
The weekly view of AT40 (T2108) shows the sharpness an uncharacteristic swiftness of the indicator's rebound from oversold levels.
The weekly view of AT40 (T2108) shows the sharpness an uncharacteristic swiftness of the indicator’s rebound from oversold levels.
The S&P 500 (SPY) experienced two small setbacks after that overbought period ended on its way to a massive post-election rally. That episode was a reminder of how bullish overbought conditions can be for buying dips, especially following two historic oversold periods. This period not quite similar because this stock market’s overbought period is not happening at or around all-time highs. Moreover, the S&P 500 remains below the critical resistance level of its 200DMA.
{...}
On the positive side, AT200 is only at 32.4%. AT200 just recovered its losses from the December meltdown and needs to get to 46% to erase its losses from the October breakdown.
{...}
Be careful out there!
Full disclosure: long UVXY call options
Oversold Chronicles End As A Fed-Inspired Market Explodes HigherAbove the 40 (January 4, 2019) – The Oversold Chronicles End As A Fed-Inspired Stock Market Explodes Higher
January 6, 2019 by Dr. Duru
AT40 = 20.4% of stocks are trading above their respective 40-day moving averages (DMAs) (ended 13 days in oversold territory)
AT200 = 14.9% of stocks are trading above their respective 200DMAs
VIX = 21.4
Short-term Trading Call: bullish (with caveats all over again)
Commentary
All oversold periods must end – it is just a matter of how and when. In the latest case, the oversold period took 13 days to run its course and ended in an explosive display of upside. The last three chairs of the U.S. Federal Reserve sat right at the ignition point as they met on an economic panel to play cheerleader for financial markets and the job the Fed does to steer good outcomes.
What happened on Friday was essentially a continuation of the bullish signs I pointed out on Wednesday. These signs were rudely and abruptly interrupted on Thursday thanks to poor economic data, a “shocker” earnings warning from Apple, and wild gyrations in the currency market (I covered it all in the last Above the 40 post). While stocks sold-off on Thursday, currency markets steadily healed and set-up financial markets for their own bout of healing on Friday. The Australian dollar (FXA) versus the Japanese yen (FXY) is still my favorite indicator of risk attitudes, and I followed it in awe as AUD/JPY led the recovery from Wednesday evening’s low liquidity, flash crash low. AUD/JPY managed to end the week essentially flat with its pre-flash crash price. I will now be a lot slower to close out my long AUD/JPY position.
{AUD/JPY took two days to completely reverse the loss from its flash crash. Can the upward momentum continue?}
The chart above shows that the extreme of the flash crash was met by an extreme rebound. Stocks responded on Friday. The S&P 500 (SPY) gapped up and soared 3.4% to a 2-week high.
{The S&P 500 (SPY) gained 3.4% and closed just under its downtrending 20DMA resistance.}
Like the the S&P 500, the NASDAQ and the Invesco QQQ Trust (QQQ) jumped to their respective downtrending 20DMAs.
{The NASDAQ gained 4.3% and closed on top of its downtrending 20DMA.}
{The Invesco QQQ Trust (QQQ) gained 4.3% to close just under its downtrending 20DMA.}
The buying was so strong it propelled AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), out of oversold conditions. AT200 (T2107), the percentage of stocks trading above their respective 200-day moving averages (DMAs), reflected the deep technical damage remaining in the market by only managing a gain to 14.9%
{AT40 (T2108) surged to a 3-week high and created a V-shaped recovery from the depths of an extreme oversold period.}
{AT200 (T2107) jumped to a two week high but still reminds me of all the technical damage remaining in the stock market.}
The S&P 500 finished the oversold period with a 2.6% loss. It opened the 13-day oversold period on December 14th (note I had to make corrections in past posts on duration of the AT40 periods). The performance was in-line with historical performance and just below the overall projection. Friday’s surge brought an end to the risk of “scenario 3” playing out in full for an extended downward trajectory in oversold conditions. The 13-day oversold period was one of the longest in history (dating back to 1987).
{The performance of the S&P 500 for a given oversold duration (T2108 below 20%).}
Given the marginal break out of oversold conditions, I am looking for an immediate follow-through of buying before calling a definitive end to the oversold period. Recall the October sell-off where two oversold periods were separated by just one day of trading. The second oversold period took the S&P 500 even lower than the first oversold period and rendered the end of the first oversold period nearly meaningless.
The volatility index continues to suggest that this latest period of elevated volatility is coming to an end. On Wednesday, I noted how I would have concluded the VIX hit a top absent knowing the after hours turmoil. The VIX did not jump nearly as much I expected on Thursday, and on Friday the fear gauge plunged again – this time by 16.0%. The VIX still looks topped out. I took profits on my single put on ProShares Ultra VIX Short-Term Futures (UVXY). I will resume fading volatility after a large spike and/or after the VIX drops below the 20 threshold. However, I will switch to long volatility around the 15.35 pivot line as hedging should get very cheap at that point.
{The volatility index resumed its plunge from the Christmas Eve peak. The VIX even closed below its own uptrending 50DMA.}
In the last Above the 40 post, I lamented: “I absolutely hate feeling short-term bearish while the stock market is still in deep oversold territory. Yet, the trading action, and now the economic and financial data, point to an extended stay in bear market territory.” I granted one key upside scenario: “Perhaps to the upside, government action from China and/or the U.S. will trigger a buying opportunity (most likely from monetary policy and NOT trade policies).” Friday’s rally was a double reminder of the dangers of getting too bearish during an oversold period and of forgetting how central banks are ultimately beholden to respond to the misery of financial markets. While China made yet more moves to ease monetary policy on Wednesday and more on Friday, it was Friday morning’s Fed-speak that truly turned the tide.
Fed Chair Jerome Powell hung out with his immediate predecessors Janet Yellen and Ben Bernanke to talk monetary policy, the economy, and the economics profession at the American Economic Association’s annual meeting. Below I summarize and editorialize some key remarks and answers, but I encourage readers to watch for themselves. In particular, Powell’s market-moving commentary started around the 5:30 mark of the video. That moment may become a key turning moment for financial markets even if the major indices make new lows before rallying again.
Powell noted that monetary policy is all about risk management in a time full of conflicting signals from a strong domestic economy, economic weakness in China, and financial markets projecting concerns about the future. The market experienced a tectonic shift when Powell next proclaimed:
“As always, there is no preset path for policy. And particularly with the muted inflation readings, we will be patient as we watch how the economy evolves. We are always prepared to shift the stance of policy, and shift it significantly if necessary in order to promote our statutory goals…we will be prepared to adjust policy quickly and flexibly.”
This statement is standard Fed-speak and would have been unremarkable except that up to this point financial markets had become utterly convinced that Powell was deadset on hiking interest rates and keeping monetary policy on a one-way course no matter what. To me, this statement was a simple reminder of the reality of monetary policy: when push comes to shove, the Fed will move when absolutely necessary. In this case, the stock market’s near unrelenting sell-off put pressure on the Fed. As I stated after the Fed’s December pronouncement on monetary policy: “A Fed Undeterred Is A Stock Market Not Yet Low Enough.” Sure enough, prices went lower, and the Fed went to work.
In case anyone was still unconvinced of the Fed’s underlying flexibility, Powell recounted an example of Fed flexibility from 2015-2016. He gave the exact same example last month. I am sure Powell repeated this example specifically to set-up an important point: the market has misinterpreted the Fed’s methods and intentions. He even accused the market of excessive worrying (emphasis mine): “The markets are pricing in downside risks and are obviously well ahead of the data.” Despite this supposed unnecessary panic, Powell reassured markets that “…we are listening sensitively to the message that markets are sending. We will be taking into account those downside risks as we go forward.” Powell effectively said that the Fed is not worried about the economy but if markets worry enough about the economy, the Fed will (reluctantly?) take the downside risks more seriously.
Powell next addressed the issue of quantitative tightening through the reduction in the Fed’s balance sheet. Here again, Powell emphasized a flexibility that the Fed has already communicated in the past: “In 2014, we said that we would be prepared to adjust our normalization plans as appropriate….we wouldn’t hesitate to change… If we came to the view that the balance sheet normalization plan, or any other aspect of normalization was part of the problem, we wouldn’t hesitate to make a change.” Over and over again, Powell told financial markets that the Fed is flexible, responsive, and attentive. Moreover, he has been a part of the Fed decision-making apparatus for many years. It was clearly the exact reminder financial markets needed.
There were other interesting items in this meeting not covered in mainstream financial media. Most importantly, Powell, backed up by the historical references provided by his peers, reaffirmed in no uncertain terms that the Fed is independent and not subject to political whims. Powell specifically insisted that the Fed has a strong culture. These references were a direct repudiation of President Trump’s attempts to verbally bully the Federal Reserve into following the monetary policy desired by the White House. Yellen even cautioned that while Trump has the right to comment on the Fed, such public rebukes cut against the practices established by recent Presidents and threaten to undermine the public’s confidence in the Fed.
The panel also addressed whether the Fed actively works against the interest of the common worker. Starting with Yellen, the Fed chairs refuted the premise – now maniacally promoted by the likes of CNBC’s Jim Cramer as his own special method of shouting the Fed into acting in a pro-market way – that the Fed acts specifically against the best interests of workers by moving to cool the economy just as job markets heat up and drive wages higher. Yellen referred to the Fed’s data dependency and the difficulty in correlating employment growth to inflationary pressures. Powell also emphasized that the Fed has been very willing to review its estimates of the natural rate of unemployment. Bernanke noted that well-anchored inflation expectations allow the Fed more leeway in experimenting with monetary policy in an era when the link between unemployment and inflation is apparently so weak.
The market’s dovish interpretation of Powell’s comments also had an impact on the U.S. dollar index. The dollar was rejected from overhead 50DMA resistance and closed down on the day.
{The U.S. dollar index (DXY) is slowly breaking down as it churns below its 50DMA }
This currency action is convincing me to shift my bias from bullish to bearish on the U.S. dollar (without getting bullish on the euro though!). The dollar’s decline did not come with lower long-term rates. The iShares 20+ Year Treasury Bond ETF (TLT) gapped down and lost 1.2%, likely from a combination of a reduction in the fear that drove traders to the “safety” of U.S. Treasury bills and the strong December jobs report that allayed some fears of imminent economic weakness. I took profits on a tranche of TLT puts I purchased the previous day as TLT stretched far above its upper Bollinger Band (BB). This TLT fade is a new strategy I added to the toolkit for this interesting period where U.S. economic data can still deliver good news even as the fear trade drives TLT higher.
Looking back on all this Fed-driven drama, I now wonder whether this episode was just another experiment very similar to the “Taper Tantrum” where the Fed first floated the idea of getting started with monetary tightening. The market’s reaction was so negative that the Fed soon had to dial back its language and soothe financial markets. The reaction to Yellen’s first rate hike was also very negative and, once again, the Fed had to coo the market out of its panic. So here we are again. Powell flirted with outright hawkishness including floating the idea of putting tightening on a near automatic schedule, observed the market’s deeply panicked response, and is now working to calm the markets. The stakes are high given China’s economic weakness and U.S. economic numbers that are so strong they are unlikely to get much better from here.
Trading Discussion
Friday was of course a big up day for the oversold trading strategy and the kind of validation I always enjoy. If the oversold period had not dragged on so long, I would have held onto more long positions. Instead, I actively took profits. I was relieved to see that I was not over-hedged, and of course I pushed forward on fresh hedges (see below). For good measure, I added a calendar put spread on Adobe (ADBE) which is still negative post-earnings. I salvaged residual value on SPY call options that I just mistimed from the previous week. I restarted my secular bet against Walgreens Boots Alliance (WBA) with a short right at 200DMA resistance. I anticipate avoiding opening new bullish bets on Monday as I await confirmation of the end of this latest oversold period (see below for the Apple exception). I kept the short-term trading call at bullish.
CHART REVIEWS.... (included in original post)
A Deeply Oversold Market No Longer Expects Rate Hikes in 2019AT40 = 10.9% of stocks are trading above their respective 40-day moving averages (DMAs) (oversold day #2)
AT200 = 15.8% of stocks are trading above their respective 200DMAs (new 34-month low)
VIX = 24.5
Short-term Trading Call: bullish (caveats below!)
Commentary
The week started as I expected based on the technical setup on Friday that I discussed in the last Above the 40 post. The day itself was wilder than I expected, but I am not even sure why I continue to get surprised. The S&P 500 (SPY) sold off quickly in the first 15 minutes of trading. Gap buyers stepped in and managed to shove the index through the gap and into a fractional gain. The bear burden took over from there and unleashed nearly constant selling. A sharp bounce in the final 10 minutes of trading closed the S&P 500 with a 2.1% loss.
{The S&P 500 (SPY) lost 2.1% and sliced through the April intraday low on its way to a a 14-month closing low.}
The NASDAQ and the Invesco QQQ Trust (QQQ) decisively took out their November lows. These tech-laden indices avoided the fate of the S&P 500 which set a new 2018 low.
{The NASDAQ lost 2.3% and closed at a 13-month low.}
{The Invesco QQQ Trust (QQQ) lost 2.2% and closed at an 8-month low.}
The volatility index, the VIX, finally delivered a strong gain of 13.4%. Still, the volatility faders were able to put a lid on the VIX right at 26, exactly where the fear gauge came to a halt twice during the early part of December. The robots left me unconvinced that the VIX is done going up. Maybe the Federal Reserve may save the day this week, but the VIX is “due” to at least test the highs from October’s sell-off if not blast completely through those levels.
{The volatility index, the VIX, magically stop going up right at 26. The VIX ended the day with a 13.4% gain.}
The trading action allowed me to execute all my plans from the last Above the 40 post. The plunge in QQQ allowed me to take a healthy profit on my put spread (and of course I was left wishing I had the guts to buy all those puts outright). I was able to accumulate call options on the ProShares Ultra VIX Short-Term Futures (UVXY) before the big surge. I took profits on one call and held the other (with plans to sell on Tuesday). Netflix (NFLX) even rallied as much as 1% and gave me a cheaper entry point on a put which I sold later in the day (recall that NFLX is one of the stocks I target for fades on rallies). The spike in the VIX finally gave me the “green light” to start my oversold trading. I loaded up on shares of ProShares Ultra S&P500 (SSO) and accordingly dropped the “cautious” from my short-term bullish trading call.
The stock market is now deeply oversold. AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), plunged to 10.9%. The market is not quite at the single-digit low it reached at the peak of panic in October, but the near halving of AT40 sure looks violent enough to qualify for the beginning of a bottom, if not THE bottom for this latest cycle of selling.
{AT40 (T2108) was almost cut in half as it fell from 19.7% to 10.9%.}
AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, dropped to a fresh 34-month low of 15.8% as the longer-term underpinnings of the market continue to deteriorate.
{AT200 (T2107) plunged to 15.8% and set a new 34-month low.}
Neither AT40 nor AT200 can tell us anything new if they continue lower. What matters more now is the duration of the oversold period and the nature of the bounce OUT of oversold conditions. Most troubling about the above picture is AT200’s failure to recover nearly as well as AT40 did coming out of the last oversold period. With many 200DMAs now in decline, that kind of tepid bounce is a bearish sign for the longer-term outlook.
The Federal Reserve: Hero or Zero?
The Federal Reserve issues its next decision on monetary policy on Wednesday, December 19th. I have heard hopes that the Fed will decide to wait on hiking rates either during this meeting or after this meeting. The growing drumbeat of fear over tightening monetary policy is quite a turn of events from earlier in the year when most dismissed the impact of the Fed trickling rates higher from historically low levels. Those days were the tones from a bull market when bad news meant little except another buying opportunity. Now, the market is in bear market mode. Fear reigns and the search for hope is far-reaching. Here is an example of the argument for a halt to rate hikes from Jason Furman, the former Chair of the White House Counsel of Economic Advisers (click to watch in YouTube).
I think the calls for a pause in December are extreme. They certainly are way out of step with market expectations. The Fed Fund Futures are pricing in a 69.7% chance of a rate hike on Wednesday, almost exactly the same odds as a month ago with the stock market a little higher. So if the Fed decides to back down from a December rate hike, I think the market will come away with a negative interpretation: the Fed expects an economic slowdown. Why else would the Fed suddenly back down from a planned and well-anticipated rate hike? Granted, the current market sell-off might put enough fear in the Fed to take such an extreme measure.
So how about 2019?
I think most pundits at this point agree the Fed needs to take a pause after December and take time to reassess conditions. If the Fed hikes, most people are still expecting a capitulation in the form of very dovish Fed-speak about the go-forward plan. Incredibly, financial markets no longer expect ANY rate hike in 2019; exactly a month ago the odds favored June as the month to enjoy the first rate hike of 2019.
To read the table below recall that the current Fed funds rate is targeted at 2.0 to 2.25% (200-225 basis points). Assuming the Fed sticks to hikes of 25 basis points, then the next rate hike after December will target the 2.5 to 2.75% range. Those odds for that range NEVER go over 50% for the entirety of 2019! Calculate those odds by summing up the probabilities starting at the 250 to 275 column and going right. Technically, that sum represents the odds of the Fed at least hitting that target by the associated meeting date.
{Remarkably, the Fed Fund Futures no longer price in a rate hike in 2019!}
The Fed is officially trapped into going dovish in this coming meeting one way or another. If the Fed sticks by its to-date more hawkish tone, then it will face the wrath of an even more skittish market. Ironically, because the market is pricing in this dovish talk, any subsequent post-Fed rally will essentially be a sell-on-the-news moment and will usher in fears of an economic slowdown anyway. Fed Chair Jerome Powell will have to summon the verbal skills of a master orator!
American Express (AXP)
AXP joined the growing majority of stocks trading below their respective 200DMAs. This support level held up like magic during the vicious market sell-off in October. The high-volume, high magnitude breakdown is bearish for AXP. I expect 50DMA resistance to hold on the next bounce.
{American Express (AXP) lost a whopping 4.3% and closed below its 200DMA for the first time in 8 months.}
Walmart (WMT)
WMT is VERY tempting here. The stock finally finished reversing its gains that began with large post-earnings gap up in August. WMT was wonderfully contrarian throughout October, but it peaked in November short of its all-time high set in January. Now, WMT is clinging to the top 15.8% of stocks still trading above their respective 200DMAs.
{Walmart (WMT) lost 1.2% and closed right on top of its 200DMA. The stock essentially completed a full reversal of August's big gap up.}
Bitcoin (BTC/USD)
When we look back on this era, I think Bitcoin will be one of many signposts for the end of the super easy money era ushered in by the financial crisis. Cryptocurrencies were fueled by what seemed like unbounded enthusiasm and “market caps” that gained billions like the weight of participants in a pie eating contest. That unbounded enthusiasm has almost been drained out of the system, leaving mainly the die-hard advocates to keep up the fight for relevancy outside their specialized world.
For example, it seems that CNBC’s Fast Money is FINALLY winding down its unabashed love of cryptocurrencies. In Monday’s show, Fast Money rewound the tape on all the Bitcoin bulls who a year ago pulled out their rulers and extrapolated out astronomical prices for the end of 2018. In the following segment, host Melissa Lee barely disguises her deepening skepticism as a crypto permabull (Spencer Bogart from Blockchain Capital) repeats a familiar refrain during the current crash: current prices actually do not matter because the long-term is bright, a rebound is inevitable and even around the corner, and the technology is making fantastic advances. I duly noted that Spencer distanced Bitcoin from the fundamentals which bind early-stage companies to rational (traditional) pricing mechanisms; I read this to mean that Bitcoin can and will take on any price market participants chose.
NOW I am a bit more interested in Bitcoin (and other cryptos) than I have ever been. I am still nowhere close to buying, but I am encouraged by the accumulating signs that the mania phase of crypto and blockchain looks like it is finally waning. Recent Google search trends are also notable. The recent bump in interest is still tiny compared to the massive surge at the peak, but the recent rise is still being sustained during the current price extreme. As a reminder, the running hypothesis is that a jump in Google search trends at a price extreme marks the imminent end of that price extreme…in this case, a sustainable or at least tradable bottom is taking shape if the hypothesis remains correct.
{Bitcoin (BTC/USD) popped but it is like a pin dropping in a den of bears. The downtrending 20DMA is holding as resistance.}
{Google Trends finally came to life after Bitcoin (BTC/USD) plunged in mid-November as part of a major breakdown and new 2018 lows. That search interest is still at an elevated level a month later as BTC/USD continues to sell off.}
An Extended Oversold Period Ends with Important FootnotesAbove the 40 (November 1, 2018) – An Extended Oversold Period Ends with Important Footnotes
November 1, 2018 by Dr. Duru
AT40 = 21.4% of stocks are trading above their respective 40-day moving averages (DMAs) – ends an 11-day oversold period that followed a 4-day oversold period
AT200 = 32.0% of stocks are trading above their respective 200DMAs
VIX = 19.3
Short-term Trading Call: bullish
Commentary
AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), closed at X%. The move ended a very extended 11-day oversold period that followed a one day respite from a 4-day oversold period. Today was the kind of day I wanted for a punch out of oversold conditions; it even quickly invalidated a small bearish divergence. The rally in the S&P 500 (SPY), the NASDAQ, and the Invesco QQQ Trust (QQQ) were all strong enough to close at their intraday highs and surpass the previous day’s intraday highs. The volatility index, the VIX, even cooperated by falling below 20 and presumably starts the end of wild swings in the market.
{The S&P 500 (SPY) gained 1.1% in a move that confirmed the breakout from the lower Bollinger Band (BB) downtrend channel.}
{The NASDAQ gained 1.8% in a move that confirmed the breakout from the lower Bollinger Band (BB) downtrend channel. It closed right at downtrending 20DMA resistance.}
{The Invesco QQQ Trust (QQQ) gained 1.3% as it closed right at converged resistance from the 20 and 200DMAs.}
{The volatility index, the VIX, looks like it confirmed a double top. I earlier expected one final surge in volatility before the next implosion.}
I thought my footnote on the action would be the wildcard of Friday’s jobs report. However, a poorly received earnings report from Apple (AAPL) in the after hours has the potential for sending the market right back into oversold territory. Whatever happens Friday, attention should quickly turn to the midterm elections on Tuesday. No matter the results, I am anticipating a volatility implosion as the market settles into incrementally lower uncertainty. If volatility remains high, then I will have to re-evaluate my expectations for a relatively benign end to the year.
Perhaps an even more important footnote is the relative performance of AT40 versus AT200 (T2107), the percentage of stocks trading above their respective 200DMAs. AT40 ended the oversold period at a slightly higher level than it ended the prior oversold period. However, AT200 ended this oversold period significantly lower: 32.0% versus 39.6%. This disparity flags longer-term technical damage in the stock market; the rebound out of oversold conditions left behind a small group of stocks. These laggards will hurt breadth as the rally proceeds and could provide the seed for the next market topping action. As usual, I will take this process one step at a time.
This was another day to mainly focus discipline on holding my long positions and looking for more buying opportunities from the shopping list. I snuck into ProShares Ultra S&P500 (SSO) on the small pullback from the open. I am in accumulation mode for SSO shares. I added to my Walmart (WMT) call options. I launched another short Rio Tinto (RIO) versus long BHP Billiton (BHP) pairs trade this time with a bullish bias. I even purchased a call spread on Red Hat (RHT) to play the post IBM deal discount. However, I missed out on getting back into Baidu (BIDU); I blinked and the call options I targeted increased by almost 4x as the stock gained a whopping 6.0% by the close. President Trump’s claim that he would get a “great deal” with China helped ignite the fire.
A Second Oversold Period Gives 200DMAs A Fresh ChallengeAbove the 40 (October 18, 2018) – A Second Oversold Period Gives 200DMAs A Fresh Challenge
October 19, 2018 by Dr. Duru
AT40 = 15.8% of stocks are trading above their respective 40-day moving averages (DMAs) – 2nd day of oversold period following 4-day oversold period
AT200 = 33.9% of stocks are trading above their respective 200DMAs (up 6 percentage points)
VIX = 20.1 (15% increase)
Short-term Trading Call: bullish
Commentary
The 200-day moving averages (DMAs) still feature prominently in the market’s now protracted struggle to slog through oversold trading conditions. Almost like magic, the S&P 500 (SPY) closed the day right on top of its 200DMA after a 1.4% loss.
{At the intraday low, the S&P 500 (SPY) almost completed a full reversal of the gains from the day of the oversold breakout. Buyers rallied just enough to close the index right at its 200DMA.}
The NASDAQ was not quite as fortunate. Its 2.1% loss on the day pushed it just below its 200DMA. The Invesco QQQ Trust (QQQ) lost 2.3% but stayed above its 200DMA support the entire day.
{The NASDAQ closed below its 200DMA for the 4th trading day out of the last six.}
The Invesco QQQ Trust (QQQ) lost 2.3% but is still holding onto 200DMA support and an abandoned baby bottom.}
Sellers added emphasis to the return of bearish sentiment with a return of the volatility index, the VIX, to the “elevated” level of 20.1. The VIX immediately went from looking poised to drop below the 15.35 pivot to looking like it is ready to launch higher than the last high.
{The volatility index, the VIX, gained 15% to close right at the 20 level which is considered the start of "elevated" readings.}
On the currency side, the Australian dollar (FXY) versus the Japanese yen (JPY) faded from 50DMA resistance but at least it did not make a new low. At the time of writing, AUD/JPY reversed the previous loss and thus printed a potentially bullish sign for Friday’s trading. (For more background on the relationship of AUD/JPY to the S&P 500 see “The Australian Dollar and Japanese Yen Are Still Useful S&P 500 Signals“).
{AUD/JPY is rallying in a direct reversal of the previous day's negative sentiment. AUD/JPY has yet to break down to a new 2018 low.}
AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, dropped to 15.8% for a second day of this latest oversold period. The trading action is starting to look similar to the churn that occurred from April to May of this year as the S&P 500 bounced from and dropped to its 200DMA support while only once closing below that support level. A friend of mine helped me realize the high potential for the market to get stuck in another protracted period of churn until at least the mid-term elections in the U.S. (November 6, 2018). After all, almost a week into earnings season nothing has happened to break the market’s back or to assure buyers to continue a journey out of and away from oversold conditions. I will keep this scenario in mind if the market starts to frustrate both buyers and sellers.
When the S&P 500 first hit its 200DMA I bought a fresh tranche of call options. I prepared to buy a lot more if sellers washed out the close. After buyers started taking the indices off their lows, I hit the reset button on my volatility fades with puts expiring in 2 weeks on the ProShares Ultra VIX Short-Term Futures (UVXY). I also took profits on more hedges. The largest outstanding hedge was a fist full of put options on Caterpillar (CAT). This phase of oversold trading always puts my convictions and analysis to the test. While the stock market struggles to bounce out of oversold conditions, I have a strong temptation to try to time and game the setbacks with bearish positions. The problem is not just in getting caught with too many bearish positions when the market suddenly snaps back from an oversold stretch but also in taking away time from identifying the even more attractive upside opportunities.
A New Oversold Period Despite A Bullish Intraday BounceAbove the 40DMA (October 17, 2018) – A New Oversold Period for the Stock Market Despite A Bullish Intraday Bounce
October 18, 2018 by Dr. Duru
AT40 = 19.3% of stocks are trading above their respective 40-day moving averages (DMAs) – 1st day of oversold period following 4-day oversold period
AT200 = 37.7% of stocks are trading above their respective 200DMAs (up 6 percentage points)
VIX = 17.4
Short-term Trading Call: bullish
Commentary
The stock market was unable to follow-through from the previous day’s big burst out of oversold territory. AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, closed slightly lower and below the 20% oversold threshold. While I have to reset the clock to count down a new oversold period, this drop was so slight that it looks like noise. In fact, the more important technical event was the ability of buyers to rally the market well off its intraday lows. THIS move looks like a continuation of a transition of market power back to buyers.
The S&P 500 (SPY) closed essentially flat after trading down as much as 1.0%. The NASDAQ and the Invesco QQQ Trust (QQQ) did nearly the same.
{The S&P 500 (SPY) survived selling that took the index close to 200DMA support. Buyers closed the index out at flatline.
The NASDAQ also survived a drop close to 200DMA support and ended the day right at flatline.
The Invesco QQQ Trust (QQQ) looks poised to make a run at 50DMA resistance after bouncing well off its intraday low.}
The volatility index, the VIX, closed slightly down and faded well off its intraday high. The VIX now looks poised to drop below the 15.35 pivot after failing near perfectly under the 20 “elevated” level.
{The volatility index, the VIX, woke up for a stretch during the day but ended with a loss. The 15.35 pivot awaits below.}
Since I am in accumulation mode (buy the dips specifically), I automatically placed a fresh order for SPY call options. Unlike Monday’s fortuitous execution, I did not get a fill this time. I failed to adjust my order and thus failed to profit from the bullish rebound. Time is also running out on my ProShares Ultra VIX Short-Term Futures (UVXY) put options. The VIX is down 39.7% from its intraday high and down 30.3% from its closing high during this fear cycle; yet, I will likely end up with a loss trying to ride this fade. I clearly need to continue working on execution of the volatility fade. I will likely need to extend duration and choose higher strikes for the next fade of a VIX pop.
Critical Stock Market 200DMAs Pass the Oversold TestAbove the 40DMA (October 16, 2018) – Critical Stock Market 200DMAs Pass the Oversold Test
October 17, 2018 by Dr. Duru
AT40 = 20.9% of stocks are trading above their respective 40-day moving averages (DMAs) – ended a 4-day oversold period
AT200 = 39.6% of stocks are trading above their respective 200DMAs (up 6 percentage points)
VIX = 17.6 (drop of 17.3%)
Short-term Trading Call: bullish
Commentary
The average oversold period lasts 5 days. The latest oversold period just ended at 4 days. This episode was yet one more reminder why I prefer the aggressive approach to buying oversold periods over the conservative approach. The conservative approach waits to buy a sell-off until after AT40 exits the oversold period.
AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), soared from 13.2% to 20.9%.
{AT40 (T2108) soared above the oversold threshold to end the last oversold period at 4 days.}
AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, soared from 33.6% to 39.6% in a move that helped confirm a massive swing in sentiment from the bearish depths of last Thursday and Friday.
The S&P 500 (SPY) gained 2.2% in a move of pure poetry. The index gapped up to open just above its 200DMA and ran upward from there. The now downtrending 50DMA is in play as the next line of resistance.
{The S&P 500 (SPY) made a very bullish move in breaking out above 200DMA resistance with such clean and persistent precision.}
The S&P 500 only gained 0.9% for this latest oversold period. This performance is roughly in-line with the history of oversold periods and the resulting projection from this history.
The NASDAQ imitated the poetry of the S&P 500 with a gap up and rally above its 200DMA for a 2.9% gain. The Invesco QQQ Trust (QQQ) gained 2.9% in a move that bullishly confirmed 200DMA support.
{The NASDAQ gapped up and rallied away from its 200DMA. The move confirmed the abandoned baby bottom that marked the 200DMA breakdown.}
{The Invesco QQQ Trust (QQQ) made a doubly bullish move by both confirming an abandoned baby bottom and soaring higher above its 200DMA support.}
The jump in the breadth indices suggests that the market’s rally was comprehensive and broad. Even the much maligned iShares US Home Construction ETF (ITB) managed to gain 2.2% for only its second gain in 20 trading days. The volatility index, the VIX, was the icing on the cake with a 19.1% plunge to 17.2. All that remains is a complete reversal of fear is a close below the 15.35 pivot.
{The volatility index, the VIX, is now definitively on the downside slope of the latest burst of market fear.}
Speaking of fear, Reuters published a very timely article ahead of Tuesday’s rally titled: “Investors gloomiest on world growth in decade, cut U.S. equity holdings – BAML poll.” I think the following quote speaks volumes confirming the extremes of fear that just washed over the market:
“The survey, released on Tuesday was conducted Oct. 5 to 11 and canvassed investors managing $646 billion. It showed investors remained overweight equities overall, though the 22 percent overweight was just marginally off the recent record low of 19 percent…
The poll showed that a net 38 percent of respondents expected the global economy to slow, the worst outlook on global growth since November 2008…The poll showed a dramatic 17 percentage-point drop in U.S. equity allocations to a net 4 percent overweight.”
I sold my latest tranche of SPY call options into the rally; the options represented a quick double so by rule I sold. I held onto all my other short-term trading longs. I am also still holding onto my hedges. While these hedges are very small relative to my longs, I was not bullish enough during the market’s lows. For example, I did not aggressively accumulate put options on ProShares Ultra VIX Short-Term Futures (UVXY) and thus am still sitting on net losses. I took advantage of the implosion in implied volatility to add more puts.
Still, the train has not completely left the station. Plenty of upside remains until the next levels of resistance get hit and/or until AT40 hits overbought levels (above 70%). Moreover October’s tradition of outsized drawdowns means that 200DMAs could suffer another test before a sustained rally launches. For good measure, sellers might even be able to pull off a brief break of recent lows in the next dip.
Overall, it is still time to buy the dip until the market is otherwise proven guilty.
Oversold Conditions Test Critical Stock Market 200DMAsAT40 = 13.2% of stocks are trading above their respective 40-day moving averages (DMAs) – a 4th oversold day (below 20%)
AT200 = 33.6% of stocks are trading above their respective 200DMAs
VIX = 21.3 (no change)
Short-term Trading Call: bullish
Commentary
All eyes are now trained on the stock market’s critical long-term moving averages as oversold conditions stretch into a fourth day. AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), increased to 13.2%. This level is still very low, but it set up a mild bullish divergence with the S&P 500 (SPY). AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, increased to 33.6%.
The S&P 500 (SPY) lost 0.6%. More importantly, the index closed below its lower Bollinger Band (BB) for the fourth straight day and faded from resistance at its 200-day moving average (DMA). These technical dynamics are signs of sellers staying in control even as the slight increase in AT40 suggests a rebound is imminent.
{The S&P 500 (SPY) wilted 0.6% as it faded away from 200DMA resistance.}
The NASDAQ also faded from 200DMA resistance but closed above its lower-BB with a 0.9% loss. The Invesco QQQ Trust (QQQ) lost 1.2% but held 200DMA *support* in picture-perfect form.
{The NASDAQ is critically sandwiched between an abandoned baby bottom and a fade from 200DMA resistance.}
{The Invesco QQQ Trust (QQQ) lost 1.2% but held onto two critical supports at the abandoned baby bottom and 200DMA support.}
The ever-sinking small caps flipped the script with a day of relative out-performance. The iShares Russell 2000 ETF (IWM) gained ever so slightly at 0.4% as the index held recent lows.
{The iShares Russell 2000 ETF (IWM) is struggling to cling to critical support at the low point of the big May breakout.}
The volatility index, the VIX, was flat on the day. At 21.3 it is still in an “elevated” position above 20.
As a reminder, the average oversold period lasts about 5 days. As the oversold period stretches out, I start monitoring the performance of the S&P 500 during this period. After about the 6th or 7th oversold day, the projected performance of the S&P 500 while AT40 trades under 20% starts to decline. By the 9th day, the projected performance flips negative and steadily declines from there. Since going oversold the S&P 500 is down 1.3% (measured from the close of the first oversold day).
{The performance of the S&P 500 for a given oversold duration (T2108 below 20%).}
I set a low ball offer for SPY call options expiring next Friday that I thought would only execute a deep swoosh downward. The rush for the exits right at the close turned out to be enough. Per the oversold strategy I have laid out in earlier posts, I will accumulate more SPY call options on VIX spikes that send the market into even deeper oversold territory.
Oversold Conditions Deepen In Stock Market As Breakdowns WorsenAT40 = 11.2% of stocks are trading above their respective 40-day moving averages (DMAs) (oversold day #2)
AT200 = 31.7% of stocks are trading above their respective 200DMAs ()
VIX = 23.0 (an increase of 44.0%)
Short-term Trading Call: bullish (change from neutral)
Commentary
The market sell-off is unfolding quickly. AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), plunged ever deeper into oversold territory. This time AT40 fell from 16.7% to 11.2% to end the day at closing levels last seen during the epic January, 2016 sell-off.
{AT40 (T2108) fell off a cliff these past two trading days!}
Now that AT40 is so low, AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, becomes a lot more important to monitor as an indicator of longer-term health. The weekly chart below shows the multi-year overall downtrend is well-intact. So just like almost every other rally from oversold levels, I expect the next rally to end at an even lower AT200 high. For now, the question is just how much lower will sellers push AT200.
{AT200 (T2107) last closed this low in early 2016. Sellers still have plenty of room for pressing their points downward.}
As the breadth indicators continue to drop deeper into oversold territory, the major indices are following gravity into new or worse breakdowns. The S&P 500 (SPY) wasted little time in breaking down below its 200DMA. The index stretched further below its lower Bollinger Band (BB) as it neared flatline with its 2017 closing price.
{The S&P 500 (SPY) lost 2.1% to close with a 200DMA breakdown and a 3-month low.}
Note well that for 2018 there has only been ONE Fed meeting where the S&P 500 did not tumble soon thereafter. The February swoon was of course the worst incident as the panicked selling started the day after. This time around, the panic took six trading days to get started.
The NASDAQ extended its 200DMA breakdown with a 1.3% loss. The Invesco QQQ Trust (QQQ) gave up its 200DMA support with a 1.2% loss.
{The NASDAQ closed at a 5-month low as it confirmed its 200DMA breakdown.}
{The Invesco QQQ Trust (QQQ) closed at a 3+ month low as it broke down below its 200DMA for the first time since June, 2016.}
Small caps are leading the way in erasing 2018’s gains. The iShares Russell 2000 ETF (IWM) lost another 1.9% and closed just one point above its 2017 close.
{The iShares Russell 2000 ETF (IWM) closed at a 5-month low and is nearly flat year-to-date. IWM confirmed its 200DMA breakdown.}
Much to my dismay, the volatility index continued higher today. The VIX gained 8.8% and was up as much as 25.6%. While the volatility faders were active for the 5th of 6 trading days, the VIX’s momentum is clearly higher. I added to my put options on ProShares Ultra VIX Short-Term Futures (UVXY) by rule, but the prospects for profits by next Friday are dimming.
{The volatility index, the VIX, closed at a near 7-month high with an 8.8% gain.}
I made my first purchase of call options on SPY soon after the index broke down below its 200DMA. Per the aggressive oversold trading strategy, I will continue adding to this position during the oversold period. However, I started with an expiration for next Friday, so it is possible I will be forced to reset my strategy (likely for November expiration). Until then, I will only add after the VIX has spiked at least 10% from my last purchase. At some point (soon?), I will also buy shares of ProShares Ultra S&P500 (SSO) to hold through the extent of the recovery from oversold conditions. Given the extent of the technical damage across the entire market, I have to assume a new bearish phase is unfolding where I will be setting price targets for taking profits at important resistance levels. Still, shorting at key resistance will be very case dependent.
Stock Market Cascades Down to Oversold TerritoryAT40 = 16.7% of stocks are trading above their respective 40-day moving averages (DMAs) (a drop of 14.2 percentage points to an 8-month low and the first day of an oversold period)
AT200 = 38.6% of stocks are trading above their respective 200DMAs (a drop of 7.6 percentage points to a 6-month low)
VIX = 23.0 (an increase of 44.0%)
Short-term Trading Call: bullish (change from neutral)
Commentary
Sellers dominated the trading action in a way that we have not seen in a long time…
The S&P 500 (SPY) dropped 3.3%, its largest single-day loss since early February.
The NASDAQ dropped 4.1%, its largest single-day loss since June 24, 2016.
The volatility index, the VIX, soared 43.9%, its 11th largest gain ever. The last time the VIX gained more in a single day was the record-setting 115.6% gain on February 5, 2018.
Roll out the bull, the lower prices are here and fear has finally steamrolled complacency.
In my last Above the 40 post that covered Friday’s trading action, I wrote: “So while the shorter-term indicator is at levels that have frequently marked bottoms in this bull market, the longer-term indicator is not yet creating the kind of breakdowns that overwhelm bulls with bargain signs.” The indicators are flashing bargains now. AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), plunged sharply from 30.9% all the way to 16.7%. AT40 indicates the market is oversold (below 20%), and my favorite indicator has not been this low in 8 months.
{AT40 (T2108) experienced its sharpest downdraft since the February swoon. At 16.7% AT40 went from "close to oversold" to definitively oversold!}
AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, plunged alongside AT40. AT200 dropped from 46.2% to 38.6%, a level unseen for 6 months. Suddenly, investors are looking at a BROAD swath of stocks that have broken down below their long-term (up)trends.
{AT200 (T2107) experienced its sharpest downdraft since April. At 38.6% AT200 definitively shows a market experiencing a broad-based breakdown.}
These extremes immediately give me a bias for buying. I flipped the short-term trading call from neutral to bullish. I closed out almost all my bearish positions (hedges). I started my transition to bullishness by buying put options on ProShares Ultra VIX Short-Term Futures (UVXY). The VIX’s surge is an extreme that history says cannot be sustained for long. At 20, the VIX traditionally indicates an elevated level of fear. From this point and higher, sellers exhaust themselves relatively quickly. I like starting with a volatility fade because it can still pay off even after more substantial gains from the VIX. The inevitable collapse in volatility is typically sharp enough to cause substantial losses in the long volatility products. I chose expiration dates for the end of next week to give an initial first runway to this potential action.
{The volatility index, the VIX, has returned to levels last seen in the waning days of the last big market sell-off.}
The major indices are all over the place with a mix of bearish breakdowns and lingering hopes for critical support to hold. This downward cascade of selling and breakdowns means that the selling can continue for another day or two before a relief rally off the oversold extremes ensues. In particular, the S&P 500 has not yet quite tested 200DMA support. The index last touched this critical long-term support in May and only closed below its 200DMA ONCE during the sell-off earlier this year. Before that episode, the index last tested support during the election related swoon in November, 2016 and last closed below the 200DMA in June, 2016. In other words, traders and investors alike should be watching the coming showdown with the 200DMA very closely. I was amazed to see the important 2800 level give way so easily, especially with the S&P 500 already so far below its lower Bollinger Band (BB). The index is extremely extended to the downside here. Ditto for the tech-laden indices and small caps.
{The S&P 500 (SPY) dropped 3.3% in a path that took it all the way from 50DMA support to within less than 1% of 200DMA support.}
{The NASDAQ confirmed its 50DMA breakdown with a bearish 200DMA breakdown. The NASDAQ last traded below its 200DMA in July, 2016!}
{The Invesco QQQ Trust (QQQ) lost 4.4% and closed right on top of its 200DMA in a move reminiscent of its picture-perfect close on top of 50DMA support 4 trading days ago.}
{The iShares Russell 2000 ETF (IWM) confirmed its bearishly precipitous slide with a 2.9% loss and 200DMA breakdown.}
{The Financial Select Sector SPDR ETF (XLF) lost 2.9% in a move that confirmed 50/200DMA resistance.}
{The SPDR S&P Retail ETF (XRT) lost 2.5% with a 200DMA breakdown that confirmed the end of the rally in retail stocks.}
A washout of sellers is a great way to resolve oversold conditions, but such a cataclysmic end seems so regularly elusive. A gap down at the open would generate the right amount of panic to force out even the most reluctant sellers. A gap down would put the major indices at an unsustainable extreme below lower Bollinger Bands except in the case of massive successive waves of selling characteristic of a bear market. However, instead of a gap down what often happens in these cases is that the follow-on selling in international markets somehow satisfies the selling urges in the U.S.; buyers eagerly jump into the market right before the open. On the flip side, a gap UP would leave a lot of motivated sellers awaiting higher prices to unload their burdens. In any case, the 200DMA breakdowns in the major indices provide good tells of the potential limits (resistance) of the first relief rally.
Per the AT40 oversold trading strategy, I will get more aggressively bullish the lower AT40 goes. Additional extreme upward changes in volatility enhance that aggressiveness. With earnings season presenting a lot of stock-specific risk, I will mainly focus on the major indices for buys. The less aggressive strategy features waiting for the first sharp pullback in volatility while AT40 is oversold or to wait until AT40 ends its oversold period. Always note that an oversold market can get more oversold and the end of one oversold period can lead to a new one. In a bull market, supports hold and oversold periods are short-lived. The February swoon started with a 1-day oversold period followed by a 4-day oversold period. Three weeks later, AT40 dropped close to the 20% level before bouncing never to return until now.
I enjoyed reading and listening to many of the narratives swirling around to explain the market’s sell-off. Few, if any, are useful because they all have to do with data and information we have known for quite some time, including the Fed’s slow and steady rate hikes. The main difference now is that the market suddenly cares about the negatives and the headwinds. Most importantly, the current sell-off reminds us that poor (and shrinking) breadth during a strong run-up is a sign of underlying weakness. I saw a number of pundits claim that breadth was fine and/or that a narrow market did not matter given strong economic fundamentals and corporate earnings.
The truly new catalysts will come with the stories companies tell about earnings as the season kicks off in earnest in a day or two. I have already noted two companies that sent up important warning signs: Acuity Brands (AYI) and PPG Industries (PPG). Fluor (FLR) provided more bad economic news in the after hours session.
Not A Bear - Just A Bull Looking for Lower PricesAT40 = 31.0% of stocks are trading above their respective 40-day moving averages (DMAs) (was as low 28.1%)
AT200 = 46.7% of stocks are trading above their respective 200DMAs
VIX = 14.0 (was as high as 15.8)
Short-term Trading Call: neutral
Commentary
So much for a small bounce before continuing a decline toward oversold conditions!
The jobs report for September seemed to be a non-event as the S&P 500 (SPY) opened slightly higher and drifted higher for the first 15 minutes of trading or so. By the second breakdown to an intraday low, it was clear that sellers were eager to hit the exits. For the S&P 500, the selling ended just below its 50-day moving average (DMA). Buyers took over from there and pulled the index back from an ominous 50DMA breakdown.
{The S&P 500 (SPY) briefly broke down below its uptrending 50DMA support before buyers rallied the index back to its intraday low from the previous trading day.}
Like the S&P 500, small caps gave some faint hope of a bottom as buyers picked the iShares Russell 2000 ETF (IWM) off the very critical support of an uptrending 200DMA.
{The iShares Russell 2000 ETF (IWM) closed at a 4-month low after buyers picked the small cap index off 200DMA support.}
The parallel selling in the NASDAQ confirmed a 50DMA breakdown. The selling in Invesco QQQ Trust (QQQ) created the 50DMA breakdown that the tech-laden index barely avoided the previous trading day.
{The NASDAQ closed near a 3-month low as sellers confirmed the previous day's 50DMA breakdown.}
{The Invesco QQQ Trust (QQQ) reversed all its gains from late August with its 50DMA breakdown.}
The selling even took down financials which had rallied going into Friday’s jobs report. The Financial Select Sector SPDR ETF (XLF) lost 0.4% after 50DMA resistance rejected it and sent XLF to a fresh 200DMA breakdown.
{The Financial Select Sector SPDR ETF (XLF) turned back neatly from 50DMA resistance and again broke down below its 200DMA.}
At the height of the selling, the volatility index, the VIX, soared to a 22.1% gain. This move was below the previous day’s 36.4% intraday high. The VIX closed with an even smaller gain of 4.2% as the volatility faders went into hyperdrive after buyers started defending critical technical levels on the indices. The VIX even closed below the 15.35 pivot in a demonstration of the continued stubbornness of bullish sentiment that keeps tilting toward complacency.
{Faders pushed so hard on the volatility index, the VIX, that it swung from a 22% intraday gain to a 4% close below the 15.35 pivot.}
Finally, AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, dropped into the 20s for the first time in 6 months. The buying off the lows only took AT40 back to 31.0%. AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, dropped to a 5-month low by closing at 46.7%. So while the shorter-term indicator is at levels that have frequently marked bottoms in this bull market, the longer-term indicator is not yet creating the kind of breakdowns that overwhelm bulls with bargain signs.
This spot is particularly tough for making a short-term trading call. I left the short-term trading call at neutral only because the risk of new short positions is pretty high at this juncture. I closed out some shorts and put positions last week even and have nothing new on my list of shorts. This is a better time to prepare to buy. In other words, I am purposely avoiding getting bearish so that I can be ready to buy the market at lower prices. Recall that October is one of the riskiest months of the year in terms of potential drawdowns. Yet, with November and December offering two of the lowest risk months of the year, October can offer some timely buy-the-dip opportunities.
{August, September, and October are the S&P 500's most dangerous months on an average basis. On a median basis, maximum drawdowns do not have such a dramatic spread of performance.}
I am guessing that October is all the more dangerous this year given the exceptionally strong stock market performance in the third quarter (July to September). In other words, the market is “due” for more than a garden variety 1% or 2% drawdown on the S&P 500.
I think technician Carter Worth made a good case for a retest of the 2800 level on the S&P 500. See below.
The 2800 level was important as resistance in June and then important as support from July to August. By the time the S&P 500 gets back to 2800, uptrending 200DMA support should be there to meet the index with a kiss. More importantly, AT40 should also be at or near true oversold levels (20%).
Even with this mental model, I am preparing for the possibility that last week’s selling was about as good as it well get. After all, sellers dramatically failed twice to keep the VIX elevated. If I see enough sign of buying power, small caps, IWM specifically, would be the obvious place to start under the assumption that 200DMA support is holding. A complete reversal of Friday’s losses would be a good first sign.
The Stock Market's Anchors Ignore Over-Stretched Conditions AT40 = 38.9% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 51.6% of stocks are trading above their respective 200DMAs
VIX = 12.1
Short-term Trading Call: neutral
Commentary
Looks like I had good reason to give a tepid endorsement to the upside potential for the stock market off the over-stretched conditions on display in AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs). The S&P 500 (SPY) had every reason to rally robustly in the wake of a trade deal among the U.S., Canada, and Mexico. Instead, the index only gained as much as 0.5% or so before reversing almost the entire gain. Only a desperate bounce in the last 15 minutes of trading took the index to a 0.4% close.
The S&P 500 sustained a hollow victory with AT40 sinking on the day to close below 40% again. AT40 has not looked this bad since April. Now I think the risk of going even lower is somewhere higher than 50%.
The anchor from small caps weighed quite heavily on AT40. The iShares Russell 2000 ETF (IWM) opened up and promptly faded from resistance at its 50DMA. IWM closed with a 1.3% loss and a 6-week low. A downtrend continues from IWM’s last all-time high.
The market did not worry about the broad, underlying weakness betraying the small gains on the S&P 500. The volatility index, the VIX, closed LOWER by about 1%. I went ahead and bought a small amount of SPY call options expiring October 8th that I plan to sell on the very next bounce or a fill of Monday’s gap up, whichever comes first. Beyond that trade, I am even more wary about the market than I was in the last Above the 40. I am still keeping the short-term trading call at neutral just out of deference for the relatively low level of AT40 while the S&P 500 remains above important support at its uptrending 20DMA.
CHART REVIEWS
General Electric (GE)
Last week I made the case for waiting on GE before making a fresh trade on a bottom. Then out of nowhere, GE replaced its CEO with former Danaher (DHR) CEO and current GE board member Larry Culp. The market’s initial reaction was extremely positive and easily cleared the thresholds for more safely playing a bottom. However, the stock failed to hold the best levels at the close and thus shut the down the buy trigger. GE even closed under its downtrending 20DMA; GE went from breakout to fakeout. This sharp fade makes a more aggressive trade even more risky than it looked on Friday.
CNBC Fast Money’s Karen Finerman made a case for a GE bottom from a fundamentals perspective. Like me, she likes the January 2020 call options. She is targeting the $13 strike while I have $15 strikes from an earlier dip.
iShares 20+ Year Treasury Bond ETF (TLT)
Speaking of bottoms, TLT violated the bottom that I thought was secured with last week’s Federal Reserve announcement on monetary policy. Still, I doubled down on my TLT call options as they have suddenly become a very cheap hedge on bullishness. I fully expect TLT to soar again if the market sells off at some point this month.
Tesla (TSLA)
TSLA delivered major relief in line with CEO Elon Musk coming to his senses and settling fraud charges from the SEC. In keeping with the tantalizing theme, TSLA nearly perfectly filled Friday’s gap down. As is its habit, the stock even closed at an obvious technical level which in this case was 50DMA resistance.
United States Oil (USO)
I suddenly see an elephant in the room: oil. Oil prices soared today perhaps in sympathy with Canada and the U.S making nice on a trade deal that includes Mexico. Whatever the reason, oil sitting around 3-year highs is NOT good news for consumers. Moreover, inflation watchers are likely starting to worry about inflation expectations creeping higher along with oil prices. I am now watching oil a lot more closely.
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An Over-Stretched Market With Notable AnchorsAT40 = 41.2% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 51.6% of stocks are trading above their respective 200DMAs
VIX = 12.1
Short-term Trading Call: neutral
Commentary
The stock market is stretched yet again based on AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs). AT40 closed the week at 41.2% after opening at 37% on Friday and closing at 38.7% on Wednesday. AT40 was last below 40% in late March and early April when the S&P 500 was in the process of forming a double bottom from the February swoon. AT200 (T2107), the percentage of stocks trading above their respective 200DMAs, also broke down to a 3-month low. So on a relative basis, the S&P 500 (SPY) is not likely to go much lower from here without a specific and very bearish catalyst. The S&P 500’s ability to levitate above its uptrending 20DMA adds to the impression that support will hold.
The NASDAQ and the Invesco QQQ Trust (QQQ) were last at all-time highs at the end of August. Both indices spent most of September pivoting around their uptrending 20DMAs. While the NASDAQ still looks locked into the pivoting, QQQ looks like it is breaking away.
While these indices are holding up well, other major indices have created anchors weighing on AT40.
The iShares Russell 2000 ETF (IWM) sold off enough in September to break down below 50DMA support. The Financial Select Sector SPDR ETF (XLF) broke out for a brief moment in mid-September only to reverse sharply. XLF ended September at a 5-week low and 50/200DMA breakdown.
The home builders represent another sector weighing on the market. On a percentage basis they are small, but the fresh technical breakdown last week spoke volumes.
The volatility index, the VIX, muddles the technical picture. It dropped on Friday to 12.1. I typically would look for a rebound in the VIX from these levels; it is hard for me to expect a fresh rally in the stock market from here. Of course, a rally is still possible and would likely push the VIX to or into extremely low territory below 11. From there, the historical record shows the market can continue a bull run for quite some time. August’s very brief stay below 11 was a notable exception.
Earnings season is coming up as the next major catalyst for the stock market. Until then, I cannot get too excited about the market’s upside prospects, but I also cannot get bearish with AT40 as low as it is.
A Bearish Divergence Intrudes On the Stock Market's Surface CalmAT40 = 48.0% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 54.7% of stocks are trading above their respective 200DMAs
VIX = 11.8
Short-term Trading Call: neutral (downgrade from cautiously bullish)
Commentary
I am not even going to try to explain why emerging markets and trade-sensitive stocks started this week so well in the wake of the double whammy of increased tariffs between U.S. and Chinese trade and a surge in U.S. long-term bond yields. Explanations might require trite and worn hindsights like “the market has already priced in the bad news” or “the bad news is not as bad as the market feared.”
Instead, I am watching closely the emergence of another bearish divergence.
The S&P 500 (SPY) made a marginal gain to close just under its all-time high. The previous day, the index bounced neatly off uptrending 20DMA support. Yet, AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), failed to follow. AT40 even sank on Wednesday to close at 48.0%, right back to its recent lows.
In recent posts, I have described the market as “stretched” when AT40 traded at these levels. Both times I traded SPY call options profitably. THIS time, I am watching warily as the divergent paths of AT40 and the S&P 500, small as they are, created a bearish divergence. With the volatility index, the VIX, breaking hard below 12 again, I am expecting a downside resolution to the bearish divergence: complacency is getting back to an extreme and the VIX has not recently spent much time at these low levels. I will be looking to reload on call options on ProShares Ultra VIX Short-Term Futures (UVXY). If I am wrong, then the VIX will likely sink further into extremely low volatility (ELV) territory (below 11). Such a move would force me to evaluate whether to make some new long plays. In the meantime, I downgraded my short-term trading call back to neutral in deference to the increased downside risk for the stock market.
Parabolic Moves Highlight FOMO Warm-Up Time on the S&P 500The S&P 500 is starting to rip higher in an early parabolic move that could start looking like January's fear of missing out.
Parabolic Moves Highlight FOMO Warm-Up Time drduru.com $SPY #VIX $AMD $TLRY #AT40 #T2108 $STUDY
Stock Market Weaknesses Confirm Earlier Bearish DivergenceFirst came the bearish divergence and next came the confirming sell-offs. Break downs in key stocks exposed underlying market weaknesses.
"Stock Market Weaknesses Confirm Earlier Bearish Divergence" drduru.com $SPY $QQQ $IWM #AT40 #T2108 #VIX $VXX $AAPL $ACIA $FB $GOOG $TWTR $NLSN $BHP $RIO $CLF $CAT $CMG $DPZ $GE $INTC $MSFT $NFLX $ORLY $QCOM $TLT $UPS $WBA $WHR $XLB
Sellers Reward A Weak Stock Market Bounce With A Bearish FadeAfter a gap down to start the week, the S&P 500 (SPY) pivoted around its 50DMA. The week ended further confirming a bearish market turn.
Sellers Reward A Weak Stock Market Bounce With A Bearish Fade drduru.com $SPY $QQQ #T2108 #AT40 #VIX $UVXY $AAPL $AMZN $AXON $GS $CCS $PHM $TOL $KBH $MDB $PZZA $SNAP $TLT $ULTA $USO
A Fed Buzzkill Ends Ambitions for An Overbought MarketA poor reaction to a hawkish Fed ended the overbought period at 2 days. The S&P 500 is now poised for a pullback.
A Fed Buzzkill Ends Ambitions for An Overbought Market drduru.com $SPY $QQQ #VIX #T2108 #AT40 $ITB $LEN $AAPL $TLT $DXY #forex
