Volatility Forecasting

Retesting Critical Support Levels

2010-06-30T13:45:00.000-07:00

After recovering about 6% from the lows at the start of June, the markets not only have given that up but stand at critical support levels. The DJIA today closed at 9,774 and on our last post (20 days ago) the markets were at today's levels, however, back then we believed a breakout to the downside was highly likely.

This time around we continue to hold our view that markets are in a market downtrend which began in May, you may read it here. Volatility has began another important up wave and a break to the downside seems inevitable, perhaps this coming Friday.

Good Trading.

Probably Get Ready for Another Upturn

2010-06-10T19:35:00.000-07:00

All along the trade on Thursday we noticed how volatility is holding onto what appears as a significant support level. The 10 day VXO intraday chart below reveals what could be an imminent upturn in volatility, perhaps as soon as tomorrow. Again, notice both the importance of the support levels and the resemblance of the 2 patterns we have circled in red. If indeed the second pattern which was completed at the close of trade today proves to be the exact clone of the first, we could finally see volatility retest the recent all time highs. This would mean a continuation of the downtrend for equities and the Euro.

It's Beginning to Hurt

2010-06-06T09:46:00.000-07:00

We welcomed Friday's 300+ point drop in the Dow and the Euro sinking to the $1.19 level since it is clearly inline with our forecast. The good news is that we might already be approximately half way there to the bottom, the bad news is that given the down move Friday, volatility just mounted a 15% rise. On our last post we reasoned that a 500 point drop would take volatility to the highest highs, the fact is that since that post, the market has just fallen by 100 points while volatility is nowhere near the highs. We have reiterated this point on numerous occasions throughout this blog and is one of the very fundamental key aspects of volatility up and down moves. To the extent that market drops are greater than volatility up moves, this gives a subtle indication that we are nowhere near the bottom, in fact, we might be in the midst of the most severe down wave.

We can see this clearly in the 3 month daily chart below, where despite volatility having moved within a tight horizontal range this week, the market has fared much worse, in fact, this week the Dow was down 3%. If we see a break to the upside of the 35 level this week, this will trigger another or even worst wave of panic selling on Wall Street and all across the globe. So the Euro could reach our $1.15 level, the question remaining is who will be to blame, Greece is already "water under the bridge", however, there is no lack of troubled Mediterranean countries to blame. The story crossing the wires on Friday was Hungary, we'll just have to wait and see.

So where do we stand in terms of our April 4th post where for the first time we stated that this could be the right time to start liquidating long positions. Back then, the Dow was at the 10.927 level, since then, the down move has been 10%, quite sizable indeed. However, if we take the highest level of the Dow which was reached later on that month, the fall from highest high to Friday's close is closer to 12%. Regardless of one or two percentage point difference, between both estimates, this constitutes in it's own right a respectable market correction, however, the question is whether this is in fact just a correction or as we said back on April post, the start of a bear trend. This is the real question.

Expect More Bleeding

2010-06-01T14:44:00.000-07:00

Today's volatility rise of 13% is clearly the start of another wave up which will soon make it retest last week's resistance levels. For the equity markets this is bad news and the fact of the matter is that the bottom is nowhere in sight. We are very likely to see the lowest lows from last week been penetrated. To put try to put the recent fall in perspective, the Dow could easily fall another 500 points (currently it stands at 10,024) while volatility might just be retesting the highest highs...

In a news article today, the Bank of Tokyo-Mitsubishi UFJ Ltd cut its forecast for the euro to $1.16 by the fourth quarter, which is inline with our $1.15 forecast we gave two weeks ago and which you can read here. Given the timing of today's forecast by the Bank of Tokyo, they are implicitly assuming that the stock market correction is real and will last throughout this summer and well into the fall.

Dangerously Close to the Abyss

2010-05-24T17:39:00.000-07:00

Markets begin the week with continued weakness across the board and this should come as no surprise after all was said in the last couple of posts. It truly looks like markets won't give long position holders a break to allow them to close these at somewhat higher levels.

Our gut instinct based on countless historical market patterns tell us that although markets are now retesting what appears as a somewhat relevant psychological support levels especially for the Dow, the market will strongly break below probably this week, and that will probably take the Euro close to the $1.15 mark as we pointed out before.

Keep watching volatility.

This is Just the Beginning, Part Two,

2010-05-20T16:53:00.000-07:00

Today the markets plummeted, and the fact is that the market correction we have been pointing out all along seems to be in full swing. The violence and intensity of the fall is such that in the first 20 days of May the accumulated fall has been approximately 10%, but that means little unless we keep an eye on the corresponding volatility indexes.

On our last post we threw in a 4-year historical VXO chart where we presented a very serious round bottom formation, the breakout taking place a week or two after our April 4th post. And the fact of the matter is that with today's almost 400 point drop in the Dow, one should really start to worry about the magnitude and intensity of the fall that is yet to come.

Recently we have been flooded with e-mails asking if this is the real deal or if the market will attempt a last rebound only to resume its fall. Luckily for us, we closed positions more than a month ago, but for those long and/or holding onto losing positions, the situation looks very grim. One thing is clear, if the current equity selloff snowballs, there wont be a clear stop to volatility on the upside at least in the short term. Nevertheless, for those long, at this point it might be a good idea to hold on and wait for the market to completely bleed, because a rebound is likely, and that might be a good point to close longs. Having said this, volatility likely wont give a break, so until then the best thing is too wait and see.

This is Just the Beginning

2010-05-16T17:45:00.000-07:00

Don't say we didn't warn you. Last week was a real roller coaster for the stock markets worldwide. In the US the major indexes managed to rebound after having plunged but on Friday we saw a weak close that points to further weakness to come. And the real story of the last two weeks or so is not the tragic events taking place in Europe, but an "awakening" of volatility or "fear" as we pointed out on our April 4th post.

So where do we stand? Well, we don't yet see sign of volatility abating, in fact on Friday might have initiated a third wave up which could make it retest the resistance levels of around 40 for any of the major volatility indexes, right now they have readings of about 30. But that could be just the beginning if we take a look at a 4 year historical chart of the VXO which appears below and which was the inspiration for our April post. If indeed volatility has bottomed out, we could be at the start of a bear market which could take the markets seriously low. And the justification for the next wave down might be that Spain is in trouble and it could be the next to go bust, bringing another wave of fear to the markets and taking the Euro down with it to the $1.15 mark which could occur before the summer starts. Regarding the stock market, how low could it go?... Only volatility will tell.

Fear is Back!

2010-05-06T23:55:00.000-07:00

Back on April 4th we wrote that the major fear "gauges" were pointing toward a bottoming out formation after having the lowest readings in years. Call it "Greece" or whatever you want, but the reality is that today, volatility indexes such as the VXO and/or VIX spiked up in a manner similar to an event such as 911, ending the day up more than 20% each. Whether this is the start of the bear market move or not, its something to be keeping an eye on this week...

It's Been a Long Time

2010-04-04T11:33:00.000-07:00

Ever since our last post last year, there has not been a real opportunity to think about going short in the medium term. Six months later, the DJIA has climbed about 10% while the major gauges of volatility stand at historically low levels. Both the VXO and the VIX have the lowest readings in more than 2+ years, but its the support levels that are of interest to us.

The pattern that could be in the works could take the market very low, perhaps it could be the start of another bear market or just the last leg down that many technical strategist have been waiting for since last year.

The graph below is definitely telling us something, and for the first time since last August, it could be a good time to start liquidating long positions.

Good Trading.

The Big Picture

2009-11-15T21:10:00.000-08:00

Watch B. Prechter's very revealing interview on his bullish stance on volatility, pessimism on stocks, fractal stock market structure, etc.. here.

Higher Volatility Levels Expected this Week

2009-11-04T18:44:00.001-08:00

Today we experienced one of those trading days on Wall Street that remind us of topping formations or exhaustion periods, especifically when an hour before the close markets literally tank, giving up all the day's gains which were on average more than 1%. So what really happened?

Volatility is still in play and despite it having topped out in the very short term, in fact, today it was attempting to head down all over again, something happened that caused a drastic intraday reversal, responsible for a close well above the open despite the markets very positive session thoroughout the trading day.

To conclude, at the very least we are likely to see further retesting of the resistance levels along the 30 level for the VXO in the coming days, and possibly we might even see this level shattered only to see volatility head up even higher. But this wouldn't be a surprise, after all, this is all part of the trend we've been seeing in the last week or so of an important bottoming formation in the major volatility indexes. Again, we remain pessimistic about the deteriorating scenario of the stock market and despite the effort this week by the bulls, the correction for good or for worse is still in full swing mode.

Please Fasten Your Seat Belts

2009-10-30T14:57:00.001-07:00

It was the news of the day, and to some of us of the year; in fact, today's volatility surge was the biggest in the year so far and this is what news financial anchors were repeating all throughout the day. However, to a certain extent it was quite challenging to reconcile, especially in the light of yesterday's "supposedly" robust GDP figures which gave way to a 150 point surge in the Dow.

Last Monday we said that that day's volatility surge was just the beginning and we gave an approximate first level target for the VXO: 28, it closed at 23.28 that day. Two days later we continued to stand by our forecast when in fact that day the VXO surged 16% closing at 27.08. And today, that index has not only reached the 28 level, it has closed at 28.89, a surge of 22%.

Putting this in context, this amounts to a surge of 35% for the VXO for the week and a drop of just 4% for the S&P500, and we emphasize "just" since the proportions seem rather disproportionate. On the other hand, since volatility is extremely oversold the room to the upside is virtually "infinite" and the market correction is bound to be brutal.

A Little More Room on the Upside

2009-10-28T15:29:00.000-07:00

We predicted on Monday that volatility was once again on an uptrend and we ventured to state that this bottom could be just the beginning, obviously it's still too early to judge. Today the VXO surged 16% closing at 27.08. Two days ago we gave the 28 level as a close aproximation of the first level we expect the index to reach before reassessing our initial forecast. We do want to point out today's intraday high which was just a little shy above the close, so this is one of many indications to expect the current uptrend to continue at least this week.

So what does all of this amount to? The actual market correction is about 5%, however, since the March lows no market correction has been greater than 5%, so we must continue to monitor the time series in real time for any intraday reversal pattern in the volatility series.

However, what is clear is that another down day tomorrow for the equity indexes could deteriorate the technical picture and could spread a panic which could play out for those of us betting on at least a 15% market correction.

Today's Volatility Move is Just the Beginning

2009-10-26T15:20:00.000-07:00

This last week volatility dropped to all-time lows, in fact, these levels were so depressed that the "VIX" once again became a hot topic of conversation by market commentators, strategists, financial news anchors, etc.

From VF we have maintained our belief that the continuation of the current rally would not be truly validated unless volatility firmly breaks key support levels. On our last post we were open to the possibility of volatility heading south which could culminate in the breaking of support levels, however, in these last three days all of the volatility time series have remained in a tight trading range while at the same time evidently gaining momentum, a situation similar to what happens when we compress a spring and release it, the potential energy is converted to kinetic energy.

Today the spring was released and all this kinetic energy could have devastating effects for stocks at least in the short term. We will continue to monitor volatility very closely this week although the first level for the VXO is 28, currently it stands at 23.28.

Expect the Unexpected

2009-10-20T15:30:00.000-07:00

In this last week we have witnessed how volatility likely could continue to head south even more. Like many strategists out there who have remained highly skeptical of this long lasting rally such as Art Cashin from UBS who reports every morning from the floor of the NYSE, the market reaction in these last couple of days is unfortunate since we were expecting an important correction lead by an important bottoming formation of the major volatility indexes.

Again and given the latest market signs, it seems highly likely that these indexes could probably break below important support levels as early as this week. Analyst and strategists like to refer to equity support and resistance levels, but we at VF have rarely given any importance to these, however, DJIA 10.000 could soon be well behind us.

Strong Pre-Market Open but Will it Last

2009-10-14T06:15:00.000-07:00

Futures are very strong, up about +14 points 15 minutes before the open in part due to Intel.
We will be watching closely for any signs of weakness throughout the US session, pretty much like Monday's.

We Like Today's Session

2009-10-12T13:58:00.000-07:00

This weekend we were right on target when we predicted a strong start to the futures at the open late on Sunday, yet these gains here in Europe would reverse course as the US session would get underway. The DJIA and Nasdaq indexes closed up 0.21% and down 0.01% respectively, well below their session highs.

When we say we liked today's session is because some of the volatility indexes reached intraday lows coinciding with the first hours of US trading while others managed to jumped up slightly indicating there is probably no more room down to go.

This week will prove absolutely critical as most likely we'll get some sort of resolution to all of this, although it will be in the name of corporate earnings.

In short, volatility is objectively extremely oversold and a strong market correction is already due. As long as volatility doesn't break below the critical support levels we have been pointing out all along, we will probably see volatility continue in a trading range, and this is the case, this week we could see it head up again to the 28 level. Let's hope this time that the correction is greater than 5%.

Volatility Down 22% This Week

2009-10-10T16:43:00.000-07:00

In our last two posts from last week we predicted that volatility would likely turn lower from the 28 close back on Friday Oct. 2. Since then, volatility (VXO) has dropped 22% while markets (DJIA) have risen on average about 5%. We even ventured to give potential target levels: 22 for the VXO and 9900 for the DJIA. Well, on Friday the DJIA and VXO closed at 9864 and 21.76 respectively.

The reality is that we don't seem much more room to the downside for volatility unless it firmly breaks below some key support levels, a scenario too early to rule out at this point. The problem with volatility breaking all support levels is that the markets which are close to reaching key resistance levels, would break these and initiate a new uptrend phase.

We are quite skeptic about the scenario we just described unless markets seriously retrace, although two weeks ago when we predicted a retracement, markets only fell by 5%. Having said this, we are looking forward to a strong open on the futures on Sunday which would add fuel to the rally taking place in Europe, but could be followed by weakness during the US session. A neutral or negative close on Monday could be a good sign that markets are attempting at least a temporary top formation.

The Trading Range Won't Last Forever

2009-10-06T14:06:00.000-07:00

Volatility has been in a clear and even predictable trading range lately which has been very positive for the stock market mainly because when volatility drops, markets tend to rise more proportionately than when volatility rises leading to a drop in the markets, at least this is the indeed the trend in this current phase of the markets.

Our last two latest volatility predictions have been quite well-timed, the latest one from last Sunday has preceded a 10% drop in the VXO, which has fueled a respectable two day rally in the stock markets, 2.6% for the DJIA. And the truth of the rally is that we like the "proportions" involved in the percentage changes for both the VXO and the DJIA, which we like to call it a "healthy" rally. However, we must be vigilant to any deterioration in the proportions which often is a sign of early divergence in the stock markets.

Volatility could have reached a temporary support level which could make market a little nervous in the coming days, although we still stick to volatility going back to 22 which could easily take the DJIA all the way to 9900.

On another note, it's interesting to read recents comments from economist Joseph Stiglitz and star market forecaster Bob Prechter which both state that markets are ahead of fundamentals. In the case of Prechter, his call for an inmediate market correction is quite striking since exactly two months ago he was calling for the same sharp correction, although this time his timing could be much accurate.

More Sideways Action Likely

2009-10-04T15:30:00.000-07:00

Despite a 5% market retracement since we called a "top" on Sept. 23rd, last Friday we became skeptical when among other things the pre-market double-digit futures losses quickly vanished within the first two hours of trading even though the market did end in negative territory. Despite two consecutive down weeks, we have a lot of reasons to be especially cautious.

So unless we see a firm breakout to the upside of volatility this week, we could be in for further volatility sideways action which given the phase markets are in, it could translate to markets possibly initiating another leg up taking them to the highs reached barely two weeks ago. Thus, volatility could easily reverse course again and take a dive this week, taking the VXO back to the 22 support level.

Struggling to Break Out

2009-09-26T14:11:00.000-07:00

Since volatility bounced off a 52 week low last Wednesday, it has climbed approximately 15% while stocks dropped barely 1% and we know what a high elasticity of volatility means, judging by similar cases in the past. However, we feel there is plenty of upside room for volatility this coming week despite having had very little price follow through this past week.

Although further retesting of last week's lows is not out of the question, we expect volatility to continue to rise; not only is the fundamental picture of the economy starting to raise red flags, but the geopolitical tensions are been brought into the equation which could be used as a perfect excuse for a sharp but highly needed market selloff.

Time to close long positions

2009-09-23T15:24:00.000-07:00

Historically, september is not regarded a good month for stocks, in fact it is one of the worst months on record. However, so far this month the stock market return has been very positive but there are still 5 days left till the end of the month. So why do we say this? If we review our last post on Sept 6th we concluded that looking to the month ahead we would probably "see the VXO return to the 23 level mark and even drift lower. Then we will surely get some sideways action which will be also positive for stock markets and this is where the TOP could be reached".

In these two weeks since our post, the VXO has indeed drifted lower but always bound within the 22 support level, yet today the VXO reached a significant lowest low of 21.09, which we consider quite relevant. During this drifting lower of volatility we have seen markets continue its upward trend pretty much as we had predicted.

However, we strongly feel that today's volatility action could amount to something more than just an historical lowest low, and although we are not able to conclude that a TOP might be in the works, nor are we certain about the magnitude of the coming pull back, we feel that now could be a good time to close long positions and remain on "standby" mode until further notice.

Surprise, Surprise

2009-09-06T16:03:00.000-07:00

After been away for a month, we turn on our computer screens, apply our trading techniques, etc.., and we see more of the same just before we left. On our last forecast on the 3rd we stated that the uptrend would continue, and it proved to be correct; in fact, the market continued to climb all throughout August. Despite a sudden 2 day drop which amounted to nothing because volatility hadn't previously attempted a lowest low, was just an excuse to buy at cheaper prices.

Nevertheless, we do want to point out that volatility's lowest low mark on the 25th could now amount to something more given that volatility is back to retesting the lowest lows. We see the first signs of an slowly developing top in the equity markets if we do in fact see volatility return to its bullish levels, yet this time could be different than other times simply because this volatility formation has continuously evolved during these last two months and it is showing the first signs of maturity.

So what's the tentative timing here? First we need to see the VXO return to the 23 level mark and it could even drift lower. Then we will surely get some sideways action which will be also positive for stock markets and this is where the TOP could be reached. And finally, volatility might once and for all initiate an uptrend, the last signs were pretty recent, on the 1st of September. But this time, volatility might initiate an uptrend and never look back again, at least for many many months.

Rally in Full Swing

2009-08-03T14:40:00.000-07:00

The S&P500 today closed above 1,000 for the first time since November 08 and it seems as if the rally could continue this week. One of the most important indicators we are closely following is the peculiar volatility dynamics during these last 2 weeks, especially after the S&P broke above 950.
In our last posts we have reiterated that rising volatility along with price was a clear bullish signal for the markets despite what renowned market strategists and investments banks are saying, such as this recent juicy article.
However, from VF we feel that the days of rising volatility could be over at least in the short term, and if the VIX has indeed began a leg down, it could really add more fuel to a stock market already on flames.

Strong Positive Correlation Between Stocks & Volatility

2009-07-27T14:42:00.001-07:00

Ever since the S&P500 broke above 950, many people are wondering if volatility has suddenly started to behave strangely since it tends to rise with stocks, contrary to what one would expect to happen. It's no secret that ever since the 9% correction some weeks ago and when markets initiated a new uptrend which we forecasted, this new leg up culminated with the breaking of the psychological 950 resistance level. Ever since this occured, volatility had to behave in this manner cause it can't go down any further. Today, some guest speaker at CNBC tried to explain it in that people are still buying puts despite the current rally, buying insurance in the case of a sharp reversal. We don't like to think of it this way.

We seem to be immersed in the third wave according to the Elliott Wave count, wave 2 was the mini correction that we spoke about before.

Since our last post where we said that volatility was bottoming out and was probably heading up, today and Friday we have seen volatility increase along with increases in stocks. However, we also did say that given a clear bottoming formation, we could also see a sharp correction and that has unfortunately not happened. It is perhaps one of the few times (and not the last) where we have fallen in the trap of higher volatility and higher stocks. In fact, what does increasing volatility and stocks mean? Many analyst associate this pattern to mean good news for bears, in fact a fellow and renowned blogger, when it first occured recently he quickly concluded that this pattern was a good omen for bears. We have reasoned in this blog on several occasions, you may read our most recent post (toward the end of the second paragraph) that ... "while many people consider a volatility divergence of this type as been bearish, nothing truly bearish in the long term has come out of volatility and the equity indexes both rising". This is good news for bulls since it allows more room for volatility to fall with markets already trending up.

Blow Off Top in the Works?

2009-07-23T18:07:00.000-07:00

Since the start of the week we have noticed how volatility indexes simply do not want to drop any further, and for the first time in a very long time we have witnessed consecutive days of rising volatility along with rising stock indexes, in fact, the S&P500 has broken above the psychological 950 level. On Monday we concluded that despite volatility's big slide last week, we expected the opposite to occur this week which may trigger a significant stock market correction. And we haven't thrown in the towel yet.

In fact, the graph below shows the VXN in 60 minute bars where we have added a bunch of technical instruments such as Bollinger Bands, MACDs, RSI's, etc.. Its pretty self-explanatory, but pay particular attention to what goes on since the start of last week. This is just one of the many reasons that may lead us to think that the markets could be in the midst of a blow off top. Either that, or it will shoot up straight to 1100. The good thing about this is that we will know very soon.

Exactly Eight Days Ago

2009-07-20T14:17:00.000-07:00

On Sunday, 12th July we wrote that we were expecting a major volatility drop for the new week, and perhaps that dropp could also be the last drop. This translated to a market rally last week, so would this be the last leg up?

Well, volatility ended last week in the red while markets rallied after 4 straight weeks of losses.

There is something which we did not anticipate and which might be about to occur; if we take into consideration today's drop of the VXO (the rest of the volatility indexes have edged up), the S&P500 futures contract has closed at the 946 level. If you have been following this blog for the last couple of weeks, we have used the phrase: "there is no going back to the 950 level at least in the short term", well we are just four points of reaching that level. What this proves again and again is the little relevance that resistance and support levels in the stock indexes have when you are using volatility as your major tool for forecasting, especially as is the case when you are trying to catch a market top. Said with different words, usually in an uptrend which we have had since March, volatility drops lead to higher gains in the indexes, this is the reason why its tricky to call resistance levels in the indexes, thus, its better to keep a real time monitoring. After having said this, this does not mean that the 950 level will be violated to the upside, in fact, this level will prove to be a battleground resistance level. A break above this level which occurs with a certain percentage degree of safety with volatility continuing to fall as it happened all along last week as well as today, we could well see the S&P500 head to 1100 as some analyst have pointed out today.

However, and despite the fact that we are just 4 points away from reaching the 950 level, we are starting to see important signs of an inminent volatility turnaround, one of the most obvious signs besides support levels is that both the VIX, VXN and QQV were up today as well as a very obvious double bottoming formation that could be in the works. And we all know what that means for the stock market.

Don't Say We Didn't Warn You

2009-07-15T15:44:00.000-07:00

Today's broad-based rally was fueled in part by the technology sector and financials. By the close of last Friday our models clearly indicated that there were high chances of a "critical volatility pullback" this week, and we posted that on Sunday.

From Monday to Wednesday, the VIX has dropped 10.7%, the VXO 10%, the VXN 13.4% and the QQV 6%; however, the DJIA has shot up 5.45%, the S&P500 5.8% and the NASDAQ 6%. At first glance, these percentages look alright, nothing out of the ordinary, however there was a divergence from about noon today when after an initial volatility selloff at the start of trading, it quickly started to recover; in fact, the VIX rose by more than 3% closing near it's highs and the VXO ended the day down close to 1%. While many people consider a volatility divergence of this type as been bearish, nothing truly bearish in the long term has come out of volatility and the equity indexes both rising. Actually, even though a volatility rise such as today's allows more room for it to fall further, the VIX close we just mentioned could pose a clear bearish sign in the very short-term.

From the E-mini S&P500 side, it could have found some serious resistance at the mid 920's level it stands today so we would welcome some pullback tomorrow.

Right on Target

2009-07-13T14:30:00.000-07:00

Exactly as we predicted on Sunday, and despite all the recent talk about the green shoots turning into yellow weeds in the light of new economic data which has coincided with a four-week decline in the major US stock indexes, the rally we´ve had today is nothing more than volatility taking a dive we forecasted in our last post.

Today the VIX, VXO, VXN and QQV fell 9.34%, 6.81%, 9.27% and 2.89% resectively and markets shot up more than 2%. The S&P500 futures contract now stands at 895.5

Especially signifiwe cant is the fact that the VIX fell much more than the VXO, in fact the VIX has little more room to fall unlike the VXO or the QQV, so are more inclined to think that its just due to the internal composition of each index. Again, there could be a little bit more room for volatility to fall, unless this is just nothing more than a single day "volatility sell-off."

Despite all of this, we could see some market pullback tomorrow which could take the S&P500 futures contract back to the 885 level, if not, its just volatility correcting as we have been pointing out all along.

Critical Volatility Pullback Expected This Week

2009-07-12T15:23:00.000-07:00

Despite volatility having bottomed a week ago, and after seeing it surge more than 20% since then, several key indicators are pointing to a very strong resistance at several key levels which means we could be seeing volatility retest their key support levels probably this week. Essentially we could be back to where we started in terms of volatility, however, markets have corrected close to 10% so far. This "last dip" in volatility could fuel perhaps the last market rally which could be good news for those who are still holding long positions and might be looking for an opportunity to sell even with losses cause after this last rally, the bear trend could regain full strength and we could see the S&P500 head to the 800 level.
As to what level the S&P500 might reach in this rally, in downtrends, volatility dips usually translate into rallies that are much less than those coming from volatility surges, so the only way to know this is to monitor it in real time. In addition to volatility, the S&P500 could have completed at the close of Friday a bottoming formation in 120 minute time bars that hinges on 2 intraday lows, both at the middle of trading on Wed and Friday.

A Chart No One is Talking About

2009-07-08T15:55:00.000-07:00

Yesterday we posted a relatively unimportant chart if we take a broader view of the markets, yet its significant given the current market correction we are in. According to purist chartists, a head and shoulders formation like the one we posted yesterday may lead to a modest correction which could last approximately one month. If this H&S pattern proves to be such, there are several techniques to try to approximate the extent of the fall and are all available in any technical analysis 101 manual.

The chart below however is known as an "Inverse Head and Shoulders" formation and it shows a weekly S&P500 chart with what may appear to be a left shoulder and a head formed on november 08 and march 09 respectively. We have even drawn what could be the neckline of the formation. What is yet to be determined is where the right shoulder migh be, yet a very rough approximation we referred to before puts it anywhere along the 800 level. Today the S&P500 closed at 879, so this means we may expect another 80+ drop, which translates to about 800-1000 point drop for the Dow.

On another note, in today´s trading we noticed some very revealing volatility spikes that could signal that it may have found an important resistance zone. This is very revealing especially for the QQV which appears below, although it can also be found either for the VIX or VXO.

So unless volatility continues on the rise during the next couple of days, we might see markets recover tomorrow as volatility looses some ground. As for the QQV, it may head to its 26 support level or even 23 which could be good news for the markets, in this case for the Nasdaq.

The Chart Everyone is Talking About

2009-07-07T17:15:00.000-07:00

Although we truly dislike to present charts, especially those filled with trendlines and technical indicators, today we could not resist not to show the chart everyone is talking about. It appears that from a technical standpoint, the DOW and S&P500 but not the Nasdaq, might have consummated a complex "Head and Shoulders" Top. We refer to this H&S Top as complex because it actually appears to have 2 right and left shoulders. Today´s resolute break below the trendline which appears in the graph below would truly represents a "go-short" confirmation for those defensive investors who would rather wait for this type of events. However, lets not forget that from the 950 level of the S&P500 which we said here probably represented the TOP, to today´s close at 881, this fall already amounts to a 7% correction. Volatility on the other hand and as we wrote on our last post is indeed having the necessary consistent follow-through at least up to now to make this fall amount to something more than a lateral movement. Today the VIX rose more than 6% regaining the 30 psychological level. The next critical resistance level is 34.57, but there will be more bleeding before markets retest this level.

The question now is whether we will see this happen this week or instead, markets could bounce back a little in an endless attempt to catch people off guard.

True Follow-Through in Volatility is Needed

2009-07-02T18:21:00.000-07:00

Since our last post markets were in full bear mode, however in the last week, markets started to drift up, in fact the S&P500 got closer to the 950 level which we have said again and again that there was no turning back to this level. This Wed the S&P500 managed to reach an intraday high of 928 at mid session, however, unlike many renowned market commentators and strategists that in the light of this recent rally have quickly flipped positions and decided to go bullish, we decided not to throw in the towel, stay silent and among other things analize and contrast the many different volatility indexes, cause always remember dont just follow the VIX, following only one can be misleading like it occured this week. For instance, on Wed the VIX dipped below the psychological 25 level only to end the session more or less back where it started, quite contradictory indeed given that markets rallied that day. Lets recall that despite the collapse of volatility last week, this week it has stayed pretty flat despite markets trending up, so this should have raised red flags.

The real key however lies in the VXO which has been the only index which has managed to withstand all the heat and stay in the 24 level all throughout the week.

So where do we go from here? Some purist technical traders are confident that today´s close firmly below the 200 day SMA implies that this might be the real thing. We continue to be bearish but we must carefully monitor volatility next week and any signs of divergence. Certainly they have certainly picked the perfect day for a brutal selloff, todays job number was bad, but we got a preliminary number yesterday so it was a given that the number was going to be bad. It just seems the perfect reason added to the 4th of July long holiday which adds more significance and uncertainly, now traders, investors, strategists, day traders, etc., have 3 long days to ponder over the economy and the validity or not of a straight 4 month rally.

We have seen in the past volatility shot up over 6 or 7 percent in one day, so we are not very impressed cause we can be back to where we started if next week, volatility starts to weaken again. What is clear is that we have a clear and very firm floor in the major volatility indexes which will prove very difficult to penetrate. Looking at the S&P500, the future now stands at 893.75 and we can expect to see further weakness till it reaches 888, it is just 5 points, which can be done at the open on Sunday most likely. What is clear is that there is no better excuse to attempt a continuation of the bear trend than what we saw today.

The VIX in Free-Fall Mode

2009-06-25T18:01:00.000-07:00

Volatility took a real beating today, most major indexes fell by more than 9%, a staggering figure for just a 2% rise of the major indexes and in modest volume... red flags are becoming ever more evident. Throughout this week we have been thinking about the news article we read two weeks ago on Th June 11th about a trader who went long and short on july call options on the VIX at two different strike prices, a transaction with a premium tag of $850,000.

If it proves that in these last 3 days markets have completed a turnaround pattern, we could see volatility indexes break their critical support levels. Already the VIX and the others are dangerously close to a real penetration and this would validate the market reversal pattern, if so, the S&P500 won´t have a problem approaching the 950 level, a level which we have said repeateadly in this blog that it was behind us at leat in the near term.

The real key hinges on what will happen tomorrow, if volatility decisively breaks below we could be be seeing volatility in the lower 20´s during the summer months.

However, all is not lost for the bears, and despite the literal collapse of volatility this week, we should see a revival tomorrow.

Contradictory Volatility Readings

2009-06-24T14:47:00.000-07:00

At this point there is little doubt that the markets are finally in pullback mode; we continue to reiterate as we have been saying since the markets topped on June 15th that there is no turning back to the 950 S&P level at least in the short/medium term. Before markets topped, there were few voices who dared to call the top, among them Prechter or Citibank but today more and more market strategists are desperately jumping into the "bear" bandwagon before it is too late. Here is a recent comment from a renowned Bank of America analyst who in her view, limits the current correction to 10% from the June 19th close. On that date, the markets had already corrected by 3% if we consider the close on June 15th to be the true top. In addition, Dan Worden who is known to have made some good market calls in the past, on his June 15th editorial said the market selloff was a "selloff to reckon with" but he wasn´t convinced that it truly represented an important downside resolution. Yesterday he concluded that the May lows will be violated, however not the March lows, these according to him won´t be tested.

We at VF believe that this market downturn represents a healthy correction in an already extremely overbought market whose economic fundamentals have lost touch with reality, that markets have been ahead of themselves is evident in the volatility readings which we have been discussing all along. We are not in a position at this point to conclude that markets will go below the March low as Prechter said in a New York conference two weeks ago. Our "gut feel" is that we are still in a bear market which began two years ago. Today´s situation is in fact quite similar to the one in March 03 when markets bottomed, lets not forget that this formation took around 9 months till completion and even though history never repeats itself exactly the same way, we don´t have much hope for a V-shaped stock market recovery.

In the last two days we have noticed volatility drop despite modest drops in the indexes, in fact the VIX dropped by almost 7%, the VXO by 5%, and the VXN and QQV by 8% and 10% respectively. These last two readings make more sense as the Nasdaq has risen today by over 1% but still the drop is not conmensurate with the rise so this should rise red flags, i.e., volatility could be gaining momentum and this could be bad news for the markets.

On another note, the chart below from Bankinter Bank charting software shows the relative performance between 3 indexes, the S&P500 in blue, the German DAX Stock Index in grey, and the Spanish IBEX index in red. Operating from this side of the Atlantic is not a secret that european stock indexes are more volatile and tend in general to overheat and or overreact much more than their american counterparts. For instance, it takes them much longer to establish a top. This time lag is significant, it is as if it takes us longer to realize the party is over. Take a look at how remarkable this situation is especially for the Spanish stock index, which despite the dip of both the US and German indexes, the former is doing all it can to keep it going.

Market Correction in Full Swing

2009-06-22T14:11:00.000-07:00

Today US markets tanked in heavy volume and it had nothing to do with geopolitical tensions or macro worries, if it had something to do with that, why today as opposed to last week, after all the world hasn´t changed that much over the weekend.

One of the two scenarios we contemplated on last Saturdays Market Update was futures trading down heavily before the US open, thus, a pretty weak open would pave the way for volatility opening with a huge up gap which was especially crucial for the VXO which was already at the edge in terms of support levels. All of the major volatility indexes ended the day up close to 15% which is truly impressive given that it wasn´t an "empty" jump, i.e., markets followed this rise with equivalent losses which is one of the many signs that give validity to today´s fall to put it simply.

Back on June 16th we said that there was no turning back to the 950 level of the E-mini S&P and we still believe that, it now stands at 889, and having accumulated more than a 5% fall, the real question is whether the market correction will accelerate in the coming days or whether it will take a breather. The fact is that volatility has plenty of room on the upside, in fact, dangerously too much room, however the real test lies at the 34,57 VIX resistance level which closed today at 31,17 touching an intraday high of 32,05 and it certainly looks as if we will finally get a retest of that level this week, lets recall that the last time it did so was back on May 26th. Instead of markets accelerating the decline in the following days, perhaps they could find in the words of the Fed this Wed any minor excuse to decrease the rate of decline, however, it would always be a temporary or minor reaction because the volatility bottoming formation has turned into a weekly one and this is very serious indeed.

Important Market Update

2009-06-20T07:04:00.000-07:00

For the first time since we started this blog, and despite a 3% weekly fall for the Dow which we had pointed out in previous posts, we have recently become highly skeptical of markets correcting.
Despite a lot of renowned market strategists increasingly becoming more bearish in the light of this week´s fall, there are some visible signs which are pointing otherwise, like the collapse of volatility all across the board but lets take a look at some weekly readings:

VIX: -0.57%
VXO: -2.07%
VXN: -3.12%
QQV: -2.89%

For the first time, the two Nasdaq volatility indexes have broken critical support levels, which explains the Nasdaq Composite Index fall of just 1.69% for the week, in addition, the VXO has closed below the level which has always tended to rebound. The VIX is the only one holding on.

So unless markets open this Sunday down heavily and continue in the European and US session, then the correction might still be alive, if the open occurs with an up gap we could be seeing more buying ahead of the US open and by then it would be already too late. Nevertheless, its also probable that they might manage to keep markets stabilized within a trading range at least until the Fed meets next week.

Divergence between the Dow and Nasdaq

2009-06-18T18:14:00.000-07:00

The markets were up for the day, despite all the positive economic news, the S&P500 closed a little shy of the 920 level we pointed out yesterday. We are a little bit worried about the volatility readings which have literally tumbled an average of 5%, however, markets indexes haven´t had the expected follow-through. This is especially the case for the QQV and VXN, these indexes are back at critical support levels. The Nasdaq is extremely overweight and could be leading the way for the Dow.

Again, tomorrow is bound to be a roller coaster ride and we expect the 903 support level of the E-mini U contract to be tested tomorrow at some point.

The Missing Link: Stocks & Currencies

2009-06-17T16:20:00.000-07:00

Despite volatility taking off yesterday, today it stock fell and markets in general wavered about as we predicted; in sum, another one of those "nothing" day. We saw this as natural reaction to a consecutive 2 day drop in the markets, among other things.

The market outlook is that markets might have turned around a little bit, in fact, today´s close has left a rather bearish outlook for volatility and a rather bullish tone for equities, and in keeping up with the timing of the week, markets should rise tomorrow and depending on the strength of the rally, we should be in a better position to forecast Friday´s move 24 hours in advance. The E-mini S&P500 tomorrow might attempt an attact on the mid to upper 920 level, right now it stands at 908.

Today´s post is different from previous ones, we are going to try to shed some light on the factual relationship between the stock and the foreign exchange markets that you won´t find on any economic or finance textbooks. Even though this blog is mainly about volatility which is a highly reliable contrarian indicator which is not only suitable for trading, it is also used extensibly in the academic arena. One of the great advantages of volatility is the very reliable support and resitance levels, however, one big shortcoming is thatby the data is bound by the opening and closing hours of the exchange (CBOE), in other words, its not a "around the clock" time series. So we are a bit tied up with just equity and volatility indexes, we need a third alternative. There is a positive covariance between certain foreign exchange time series such as the Yen crossrates with the E-mini S&P500, note that both are as global and as a continuous time series as you can find. The graph below is pretty self-explanatory, it shows an overlap of the E-mini September 09 contract with the EURJPY cross rate in 120 minute bars which explains among other things explains the current drop of the stock markets. By the way there does not exist such a positive and fit covariance between the stock indexes and any other time series, thus any investor or academic that wishes to study the stock market given the covariance, he or she has 3 alternatives: stock indexes, volatility contrarian indexes and finally the currency market, which we have coined as the "Golden Triangle".

Volatility Takes Off

2009-06-16T13:57:00.000-07:00

Nothing really out of the ordinary happened today, only that markets suffered their 2nd consecutive day of losses, a little over 1% for both the Dow and Nasdaq. A what appeared to be a real good reading for housing starts which was released an hour before the market opened as well as a slower increase of wholesale prices in May "apparently" wasn´t enough to counteract both a fall in capacity of utilization which in fact reached a 42-year low in May, along with a steeper-than-expected 1.1% fall of U.S. industrial production. We used the word "apparently" because regardless of which statistic was good and which one bad , markets would have sank anyway today. What really counts however is the spin that the media gives to the figures and how they are covered that determines which one of them is more important in any particular trading day. As for today, its pretty clear that industrial production and capacity of utilization won over housing, but had the markets rallied then the focus would have been on housing. If we were to ask an economist and lay before him or her these pieces of data, and him or her to make a prediction of what the markets would do today based on those figures, most likely he or she might conclude that markets might rise since after all a slower than expected rise in prices is the real deal isnt it? Inflation creeping up is probably the single biggest threat that the US economy can face. Fair enough, the economist made his or her pick but they later found that the markets didn´t rise as they had predicted, they actually fell pretty bad, so wheres the catch? After all, aren´t economist supposed to know better than anyone about the economy and financial markets. Well, it turns out that if one were to watch a financial news channel right at the moment that the market were enduring the worst losses of the day, surprise, surprise, one probably ended up watching a financial roundtable discussion full of market commentators and some market strategist having a difficult time twisting the inflation argument and moving from an inflation bias to a deflation one... Will the media ever put a case to rest? If the media is uncapable of explaining every twist and turn of the markets, at least they should not disinform the public.

So what really happened today in the markets that turned the market upside down again today? Again, the real story of the day was once again driven by the extreme fear in the marketplace, fear that are driving people straight to put options. In fact, volatility climbed over 5% today and the VIX is less than two points away from the very critical resistance level of 34.57, that magical level which we mentioned to in a previous post.

So looking ahead to the days to come, if we take for granted that the 34.57 level will be tested at some point probably tomorrow, what can possibly lie ahead for the markets in this "quadruple witching" Friday, cause markets seldom do what people expect them to do, and if markets have started the week with heavy losses, you should expect the unexpected. Actually, if we hadn´t started writting this blog two weeks ago with a clear bearish stance, we would probably be wise and unwind all of our positions as of late Thursday and decide to "go fishing" on Friday, however we can´t do that this time. If we assume that there is no turning back for the markets, that the 950 level wont happen anytime soon, then the only clear answer is for markets to waver about tomorrow and thursday and break above the VIX resistance level on Friday on heavy volume, and we say heavy volume, which is something we haven´t seen in at least a month, and as we all know is the piece missing in this puzzle which would give credibility for any sustainable market move.

Below is a one month DJIA daily chart with a 200 day Simple Moving Average which shows the day when price closed above which for purist chartists is a bullish sign. To us, a 200 day MA is no better than a 202 or a 210, in fact we have never included this type of analysis in our models, nevertheless they are closely watched by strategist and of course by the financial media. In the last two days we have had a close below the MA, despite last week been above the line, does this mean that the 3 month rally since March has lost its validity?

Stocks Tumble as Expected

2009-06-15T14:41:00.000-07:00

On last Thursday´s post we forecasted for Friday that the E-mini S&P500 would drift toward the 920 support level and that markets would find it very hard to break above 950. As it turned out, Friday was yet another "nothing day" with markets operating within a very tight range but closing well below the 955 high we pointed out. Those predictions did not materialize on Friday but did so today, in fact, the E-mini September (U) contract closed today at 919.50 . By the close of Friday and with the benefit of a weekly perspective we were seriously starting to think that markets could well be headed for another "nothing week", however, we realized that there were potentially a couple of events that could deliver more excitement and volatility this week. One of them was the results of the Iranian elections, remember that near the close on Friday, the Dow suddenly leaped 30 points when rumours were out that the "reformist" rival had won, later it turned out to be false, all of this amid already heightening geopolitical tensions with North Korea. Then there was the G8 meeting over the weekend with leaders, especially Timothy Geithner, hesitant on halting spending cuts, thus sending a clear message to the world markets that the danger hasn´t passed. And then we have "quadruple witching" Friday this week, in fact, the second one this year with contracts for stock index futures, stock index options, stock options and single stock futures all expiring this Friday. And if this isn´t enough, investors will have their hands full amid rising interest rates, commodity prices and the U.S. dollar.

With all of this in mind, before the S&P500 Globex session reopened on Sunday evening, our intuition based on past historical market breakout patterns tell us that usually the best day to attempt this type of market action is during the Sunday Globex session catching investors off guard and with markets already down by the time the US opens. And this is exactly what happened; the S&P500 gaped down 0.5% at the open on Sunday and during the European session the losses reached close to 1%. The main stock market gauges closed down more than 2% by the close of market today, a little off the lows of the day. Besides the strength of the dollar today, which market commentators were trying very hard to sell as the reason for the sharp fall of the stock indexes, the real news of the day and which we have been discussing in great depth in the last two weeks was the completion of a significant daily "volatility bullish pattern". Today, they all jumped an average of 10% both for the S&P (VIX) and Nasdaq (VXN). Not only is this sharp rise in volatility significant but more importantly is the fact that the rise was sustained during the whole trading session, at no point did it dip significantly. Lets recall that in the last weeks, whenever volatility jumped, it was only to fall again hours later or on the following day.

In general, we feel that the market move today is very reassuring in keeping with the general bearish tone of our posts lately. Today´s drop was in fact the worst fall in the last month, and even though the markets have endured heavier triple digit losses within a single trading session, its defenately a good start. Today´s down market move appears to be the start of the first "leg down" we have all been waiting for, however, all along this week but especially tomorrow will be critical, since historically during important market turning points, a sharp down or up day might be inmediately followed by a day of equal magnitude but opposite direction. We are not contemplating this scenario but of course it is a possibility.

Market Reversal in The Works

2009-06-11T13:21:00.000-07:00

Nerve wrecking trading session today with the E-mini S&P500 and several volatility indexes retesting critical resistance and support levels respectively. As far as the E-mini is concerned, the 956.5 level was retested near the end of the trading session and as soon as it was reached, it collapsed to close at 942.

In addition we saw a convergence of the most important volatility indexes, that is the VIX, VXO, and QQV. As we pointed out earlier today the markets opened higher putting downward pressure on volatility in fact at some point it seemed as if the different support levels would be penetrated but they managed to hold, in fact the levels were under pressure for the vast majority of the trading session except close to the finish of trading. As for the actual levels, on the 5/20/09, 6/08/09 and today the VIX reached an intraday low of 26,57, 26,41 and 26,81 respectively. As for the VXO the dates were the 5/20/09, 6/09/09 and today with readings of 26,51, 26,55 and 26,43 respectively.

Below is a 400 minute E-mini chart we presented already but in the last days the formation has stretched and become more complex coinciding with the lateral movement we have had in the markets for the last week. We have drawn two red circles which represent intraday highs around the important resistance level of 956.5. Markets tomorrow should be heading for the support level at the 920 level and well see if that holds, which judging by the daily volatility patterns that has been evolving would imply breaking through that level.

VXO Under Fire

2009-06-11T09:09:00.000-07:00

We are showing an intraday chart taken at 13:10pm EST of the VXO which is holding onto the 26.5 critical level. To the extent that we see a rebound, that would indicate another important high in the equity indexes. However, if it finally fails to hold onto this level later on today (especially by the market close) that would signal the markets could break above and what seemed to be a topping formation would be a consolidation formation within the rally. As simple as that.
Our "gut feeling" is that this level will hold today.

QQV and VIX Spread

2009-06-10T15:31:00.000-07:00

For the last two weeks, but especially in the last week, we have seen an interesting pattern emerging; the E-mini futures tend to accumulate strong gains usually in the double digits prior to the US opening bell, only to evaporate at midday but then recover those losses in the last hours of trade. While this has resulted in a sideways market action in the US, it has led to a real bull run for European stocks, so good news for those of us on this side of the pond.

Before we get into the technicals there is one thing that I am increasingly becoming worried about, and is this notion that Wall Street is publicly bracing for a pullback, you hear it everyday on CNBC, Bloomberg, floor traders, commentators, market strategists etc,. So, if the general public or the "uninformed investor" is getting ready for a pullback, will we really have a pullback?

There are some things to note on todays trading day, among them is the awakening of the different volatility indexes which at the lowest point of the markets today were up more than 6%. Below is a 10 day intraday chart of the QQV in black and the VIX in yellow. Note the recent widening of the spread as well as the relative high and low % points which today are in clear divergence, the QQV was always bound by the -6% while the VIX was down at -14% but ended down at -10%. The chart comes from Bigcharts.com.

Heavily Overbought

2009-06-09T07:03:00.000-07:00

The markets have opened about half an hour ago.
Below is an E-mini S&P500 400 minute chart which covers about 5 weeks of data. The markets have reached heavy resistance levels at the mid 940s range, it looks highly unlikely to overcome it. Oh, and the VIX and VXO are retesting the historic support levels.

Approaching Record Lows

2009-06-08T17:35:00.000-07:00

Today´s session was truly unique in terms of the intraday pattern of the VIX. On our previous post we pointed out to what appears to be visible signs of market fatigue. Today, after the Dow was accumulating triple digit losses, it formed a beautiful U-shaped intraday bullish pattern which was further reinforced by a very strong resistance level at 31.80 on the VIX or 30.60 on the VXO which proved impossible to penetrate, had it done so, the next resistance level would have been at the 34.50 level for the VIX which is the next key resistance level. To read more about the importance of this level click here.

The remarkable thing about the VIX today is the intraday spike low at 26.41 right after the open at 30.84. This low was the same as the one on 5/20/09 which lead to a significan market drop and it drove the VIX to the 34.50 level three days later on 26/05/09. If we look at the daily chart below taken from Telechart Gold software, we can compare todays spike low to the one we have circled in yellow. The latter one coincided with the point when the sideways pattern ended around late Jan 09 which lead to the last leg down of the markets to March 09 when it finally found a floor. If today´s spike low proves to be the real deal, the sideways action will be finally over.

Markets are really starting to look bad

2009-06-07T16:14:00.000-07:00

We concluded Thursday´s post on a positive note, the last paragraph read:
"So again, pretty bullish considering the scenario as it stands today, but conditions could change pretty rapidly like for instance the E-mini reaching the upper 940 level prior to the market open at 9.30am EST and then digesting the unemployment rate as bad which could be the perfect excuse for a very strong pullback...."
Right after the horrendous unemployment rate was out, in fact, the worst in the last 26 years, the E-mini which was sitting at the 945 level we forecasted on that same post, within minutes shot up to 957, setting that day´s intraday high before collapsing almost 20 points in less than hour and coinciding with the opening bell. The markets ended the day slightly to the downside.
Some things to note on Fiday´s volatile trading day. First off, the news media were trying really hard to put a positive spin to the employment figure and keeping with the Obama team´s attempt to make the public believe the US is out of the woods. They argued that the layoffs were less than on previous months and pointing toward a recovery, yet the unemployment rate shot to 9.4% when 9.2% was the consensus. 9.4% s the highest rate in the last 26 years.
At least some well informed news commentators were right to point out to a much broader means of measuring unemployment, the U-6 rate which had shot up to 16.4%. Its clear the markets didn´t buy all the artificial positive spin by the news media, so that explains why we had such a "wishy-washy" market close. If I were bullish on the markets and judging by, the markets reaction on Friday I would head straight to the "bunker" as Art Cashin, head of floor operations at UBS at the NYSE,re said last Friday when asked about how the markets looked to him minutes before the employment figures were released.
The real key here is on volatility which has found real good support levels as we have been pointing out all along.
Right now its 19:33 EST on a Sunday and the Globlex session has opened down about 0.5% on both the Dow and the S&P500 and unless something mystical occurs like the 934.5 level holding, the markets could retrace badly tomorrow, after all we have had about 14 straight weeks of gains and isn´t it time for the markets to take a breather. Oh, and about all the hype regarding the 200 day MA, its absolute nonsense especially given the current macroeconomic picture. At least a 5% retracement is due and would be very healthy for markets overall.

I could not have said it better myself

2009-06-06T17:42:00.000-07:00

The opinion below was sent last Friday to a very well known daily market editorial. It appears that the subscriber does not share his or her optimism on the markets... I agree with the former. (Personal references are omitted)
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Hi XXX,

As always I appreciated your comments on June 2, especially the fully developed explication of why you promoted the Nasdaq Brothers to primary uptrend status.

Your warning about not "using this upgrade as a short-term buy signal" is strongly stated, but perhaps an illustration might help. On 11/21/2007, you set the Dow Jones to a primary downtrend. On 11/27 - three trading days later - the Dow started a nearly 1000 point rally.

Besides the Nasdaq's accomplishments, a lot of other things happened in the world in the last few days. For example, the US Dollar Index (DXY0) reached the level where it found support in December. That bounce took the USD up over 13%. During that period, the S&P 500 fell from 904 to 676.

What else happened? Well, the CRB commodity index (CRY0) remains parked on its 200 EMA. Two transportation indexes (DJ-20, DJUSRR) are also on or just below their 200 EMA. Three days in a row, the oil proxies - DBO, USO, USL - were up on lower volume. If one looks around, there are other signs that some of the trends that have supported the rally are getting long in the tooth.

Monday, the markets were up splendidly. "A happy market", you called it. I mentioned that to some of my friends. We all think it's a wonderful phrase. My concern, however, is that the folks who set the bid/ask for implied volatility apparently didn't get the memo: while the average index was up 3.21%, VIX was up 3.87%. Now if that isn't a mixed message, then I'm really confused.

My point isn't to rain on anybody's parade. Rather, it's a comment that after it's been storming for so long, just because we see some sunshine, that's no excuse to leave the umbrella at home.

Best regards,
XXX
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And the party continues

2009-06-04T14:22:00.000-07:00

No real market surprises today from our last post.

In general, we enjoyed a strong market rally from start to end, with the exception of market nervousness during the first hour of trading which is perfectly explained by the graph below.
Before we get into that, we reiterate our view that the market is not yet reversing course, however, due to the dynamic and changing nature of markets, real turning points are extremely hard to forecast especially from one blog post to the next, as markets conditions change very rapidly, and real time monitoring is essential especially at very overbought or oversold levels.

Below is the graph we mentioned to before, and its a 5 day intraday chart of the VXO. If we look closely at the timestamp at the upper right hand corner which comes from the Bigcharts.com website, it reads: 6/4/2009 10:16am, barely an hour after the start of trade. What is significant about this chart is the red horizontal resistance at the 30.5 level that we drew, but before reaching it, it had to make its way up there, in fact the VXO started the session rising more than 3% which explains the rocky start to the session. So again, as the VXO was climbing to that level, the markets were heading down. In fact, this was the first attempt to break above this level, it did so again later, however we wanted to include this print screen here to show how our initial intuition proved to be correct as well as for record keeping purposes.

On the next graphs we include the VXO but this time we show the full daily session as well as 2 intraday E-mini charts. As for the VXO we want to pay particular attention to the ending pattern which in our humble opinion "could be" bearish. More on this on the next paragraph.

The E-mini is shown on the two charts coming up next, the first is a 90 minute intraday chart showing two weeks of historical data, the other is a 15 minute chart ideal for intraday trading, however we need both time frames for discussion purposes.
Its now Thursday, June 4th, and its roughly 19:10pm EST, the E-mini according to the reading on the graph below stand at exactly 941.75 or the "940s level" we forecasted the E-mini to be today on yesterdays post. Its even inching higher already on GLOBEX despite the bullish close. According to the 90 minute chart, the real test stands somewhere in between the 947.5-945 level which we expect could be retested tomorrow.

Finally, the E-mini 30 minute chart below is good for intraday trading and shows quite clearly the market action during the last couple of days much clearly than the 90 minute one. We see the recent market rally from the 924 level yesterday to todays. Again, from this chart we can conclude that its also likely the markets could head toward the levels we have mentioned on the previous paragraph.

So how do we reconcile the VXO with the E-mini this time? Well, its almost impossible to make any type of accurate market forecast just by playing with the equity indexes by themselves, support and resistance lines mean nothing. Its the volatility and only the volatility which can give any sort of meaning to the absolute levels on the equity indexes, without them, its pretty hard to conclude with some degree of certainty about overbought and oversold levels using the typical oscillators and the like. Since we are beyond moving averages and oscillators we will not be making any references to these in this blog, only occasionally to our custom made proprietary indicator which combines volatility with the best that oscillators can offer.
So getting back to the market discussion, although its true that the VXO looks pretty bearish, its also true that it has not fallen by much given todays market move, so we are hesitant at this time to make any firm forecast about tomorrow. We do know that tomorrow its bound to be a pretty volatile session, the key employment variable will be out and although it seems pretty obvious that the unemployment rate will break above 9%, its how much above this level that will play a key role in sentiment, thus on the VXO, but we wont know that till tomorrow. Depending on the first hour or so of trading we will be at a better position to judge market sentiment, although we do feel the upper 940 level will be retested at some point tomorrow either at the start or at the end, and there is also a good chance the markets could even break above this level.
So again, pretty bullish considering the scenario as it stands today, but conditions could change pretty rapidly like for instance the E-mini reaching the upper 940 level prior to the market open at 9.30am EST and then digesting the unemployment rate as bad which could be the perfect excuse for a very strong pullback.... All of these scenarios we have seen in the past, so any of these is possible.

Trading Volatility Intraday

2009-06-03T18:09:00.000-07:00

On yesterday´s post we were right to point out that the markets could be up for an inminent down move and we finally had it today, at one point during the session, the Dow was down close to 2% but in the last hour of trading it recovered about half of those losses, ending the day down only 0.75%

After the close of trading today and with the full view of various market indicators it seems the E-mini S&P could attempt a final leg up in the 940´s range which would mean the VIX would head down once again and complete a more complex bottoming formation, this time not on daily but on weekly time frame which would mean the eventual downturn will be on more solid ground.

A quite interesting market action we noticed today which we have already mentioned is the recovery the indexes had one hour before the close, and its no mystery to see this kind of wild market reversals occur, sometimes even just ten to twenty minutes before the close.
The only explanation for this type of action comes through a rigorous and careful real time monitoring of the VIX, VXO, VXN, etc... Below we show a 5 day intraday chart of the VXO from Bigcharts website that explains the sharp market rally we are referring to. The VXO was unable today to breakthrough the 30.5 resistance, even after two failed attempts it quickly headed lower.

Regarding the stock indexes, below we have a 30 minute E-mini futures chart that goes back to last friday, and if we take a look toward the right part of the chart we see the sharp fall which corresponds to todays market action. Within this drop we can identify the subsequent turnaround of the market near the close. Right now its Tuesday and its about 21:40pm EST and the futures are ticking up in fact it seems we are bound to have a positive open in Europe and as the E-mini continue to gain momentum to the US open we could have an extension of the late rally come through at least to the first half of trading tomorrow, at least until Europe closes at 11:35am EST. We are not so certain whether it might be able to regain all the lost ground within just one trading session, we will have to monitor the markets very closely all day tomorrow, especially the VIX and VXO.

VIX daily bottoming formation

2009-06-02T17:58:00.000-07:00

Despite Monday´s rally where the S&P, but not the Dow, managed to break above its 200-day moving average for the first time in 524 calendar days, and several sentiment indexes like Investors Intelligence recording record bullish readings (http://www.marketwatch.com/story/wall-of-worry-is-not-particularly-strong-right-now) there are still some facts that point to a reversal:
1. VIX has not penetrated through the 27-28 support resistance, in fact during the last 10 days it has formed a daily bottoming formation.
2. Lately the VIX has started to behave strangely, rising despite a rise in the equity indexes, we saw this occur on Monday and this divergence pattern are usually hints that the market could be reaching a top.
Provided the VIX finds a bottom within this week and does not retest the 27 level, the next important resistance level will be 35 and if that is reached it will mean a bottoming process will have been formed and the markets at leats 400 points down and counting...

R. Prechter predicts the Dow at 2000!

2009-05-27T14:31:00.000-07:00

Volatility indexes have grabbed so much attention in the last five years that they are now regularly quoted by the financial press and academia. Below is a recent reference to the VIX by Prof. Mankiw at the start of May 09:

http://gregmankiw.blogspot.com/2009/05/fear-subsides.html
In it he rightly concludes that this so called "fear gauge" has subsided which has been good news for the stock market indexes so far. I cannot think of any index that has such a tight feel for the markets than the volatility indexes, thus the reason for this blog.

This other article below is also about the VIX as it was covered by the financial press:
http://www.marketwatch.com/story/volatility-indexs-dip-only-a?tool=1&dist=bigcharts&symb=VIX&sid=1704273

Yesterday we were struck by the article below:
http://www.moneymorning.com/2009/05/19/robert-prechter/
In it, renowned market strategist and Elliott Wave guru Robert Prechter who is known to have made some good market calls in the last 30 years including this March´s bottom, expects the markets downtrend to resume shortly. He predicts a Dow at 2000.

Even though we have been quite bearish for the last two weeks or so we dont think we would dare paint such a catastrophic scenario. Having said that, in our last post we concluded that the market was consolidating what appears to be a topping formation and we called the second top. After that, the market has attempted a third and what appears to be an exhaustion rally, at least thats what our computer models are indicating, which has lead the markets to give up some of the recent gains. Prechter´s comment come at a right time when the E-mini S&P 500 seems to have completed the last right shoulder formation and could be in its way down. What he did not clarify though was the exact timing for the start of the bear trend.

What appears clear is that if the E-mini S&P is able to hold on to the 878-880 level and the volatility indexes continue to wander about and/or even continue to fall we wont get that bear trend anytime soon. However, if the VIX has finally woken up from its long lethargy at least in the short-medium term, we are likely to test the March lows sometime late this summer. One of the points of the previous post was trying to decipher which event could act as a trigger to initiate the downturn of the markets. As we learned today, it seems it could well be the end of the road for GM as bankruptcy looms.

The chart below is the same from the previous post but now we have drawn a third circle in black.

GM as a "trigger".. or more Swine Flu fears again?

2009-05-24T18:11:00.000-07:00

Just tonight I was reading that unfortunately a second person has died of Swine Flu in NY, and already health department officials are suggesting that the rate of infection and hospitalization might be increasing.

Also this weekend we learned that GM is locked in a critical countdown which could result in the company having to seek chapter 11 protection as early as Tueday evening depending what course of action bondholdes decide to take. In the midst of this, yesterday, Obama announced that he is confident GM will come out strong after restructuring, and although no mention was made whether he meant bankcruptcy as a means to restructure, many analysts have pointing out that bankcruptcy seems inevitable at this point.

So how do these 2 news play out with Volatility and the financial markets? Well, it so happens that whenever a major market turnaround is near, the financial media tends to pick up certain news that have the potential to change the mood of investors in such a dramatic way that if investors ended the week in a positive tone, this can be turned around in a matter of hours, in such a way that whatever positive news were released last week, it all becomes irrelevant overnight. They have the capacity to turn optimism to pessimism and vice versa with great ease.

Having said this, often times the media has an easy task in finding the right piece of news which has the right magnitude which often serves to calm investors down and justify the recent market moves. Other times, when no credible news story is available, the media is able to grab even the most absurd or remote commentary that was made that day and build up an elaborate story, again to justify the market move either one way or the other. And this happens everyday regardless of the magnitude and direction of the markets.

The problem this time is that the markets have to come down; they need to undergo a significant correction, and despite the drop of the last couple of sesions, (as was rightly predicted on the May 20th entry), we could already be on the falling phase, however the indexes have not penetrated any significant support levels yet. Last Friday, Art Cashin who is the director of floor operations at UBS, and who is known to have made very good market calls in the past, warned that he would watch the 888 level in the S&P and in the event that it breaks through, selling could accelerate. What he is implying is that if this occurs, the bear phase would be in place, and we could see the markets come back to the March lows or even lower.

So how low would the markets go? And will this occur this week? The first question can only be answered by a thorough analysis of the several volatility indexes which we will try to decipher as we go along, but to answer the second questions, and picking up on the media and swine flu, it seems the media might be pondering which one to deploy so that the fall we could experience as early as this week will be explainable, rational and even more importantly, it was just impossible to predict (remember that news reporters are trained pretty much like orthodox economists in the Efficient Market Hypothesis).

On another note, lets not forget that long weekends, Xmas breaks, the 1st day of the year, etc.., are usually the best times to catch investors off guard, so by the time we all come to work next Tuesday as will be the case this week, events could have unraveled in such a way that the action might have started without us! This is a pattern that repeats itself, so I recommend you trade with a calendar by your side.

Recently, Prof. Mankiw in his blog made a reference to the VIX, his entry titled "Fear subsides" and although he was defenately right at the start of March, VIX as we have said it might have woken up (more on this on the next blog entry):
http://gregmankiw.blogspot.com/2009/05/fear-subsides.html

Finally, below is a chart taken from the Futuresource.com website which has some of the best free historical data and charts for FX, Commodities and E-Mini contracts. Below is a 300 minute chart of E-mini S&P. If the 2 red circles prove to be a true topping formation (we called the second top last Wednesday), we could be in for a bumpy ride indeed....

VIX and a possible Top in the Equity Indexes

2009-05-20T14:06:00.001-07:00

During my usual afternoon jog I glance at my BB and the following news article catches my attention:
http://www.cnbc.com/id/30846487/site/14081545

The article titled "As the VIX Continues to Drop, Is S&P at 1,000 Far Behind?" is written by a reporter who does his/her best to present the basics of Volatility and the inherent negative correlation with the stock market indexes. What does seem surprising is to read the comments of several market strategists who in theory "specialize" not only trying to understand this negative correlation but most importantly forecast its future path (and yes this is possible). They reiterate that the recent sharp downturn in the various volatility indexes explain the recent upsurge of the stock markets, at least taking the March 09 bottom or Haine´s bottom as a reference. They also affirm that this fall is likely to persist to levels around 25 which could skyrocket the S&P to the 1000 level mark.

I agree with the first part of the analysis but disagree on the later part, and we saw this happening today. So the real question becomes whether the drop in the VIX is "always" proportional to the increase in the indexes and vice versa and to what extent. So, is there "always" a -1.0 relationship between these two and this is where these market strategists and in general, the work I have read along these lines seem to miss the point which is left unanswered either intentionally or due to lack of knowledge.

So lets look at the following charts taken from the Bigcharts Website:

A 10 day intraday VIX chart

And a 10 day intraday DJIA chart

So on the first chart, while the VIX has fallen by more than 10% the DJIA cannot seem to rise any further ...

The different volatility indexes such as the VIX, VXO, VXN, QQV etc.. always act as a leading indicator to the equity indexes and in cases as these ones are usually a wake up call to those currently holding long positions.

So the markets look as if they could have reached an intermediary Top, in fact, today the volatility seems to have woken up from its lethargy and this is always bad news for the markets.