The Trading Digest

So we have ridden down fairly far and I have noticed some of the sentiment gauges starting to lean a bit bullish which always tends to make me leery of that case. But after such a strong down thrust statistically being up versus down in the short term is the high probability play. I am curious in the the very very short term where the readers think we will finish on Friday versus yesterdays close (Tuesday). We closed at 1428.23 on the SP-500 cash index. So after the next 3 days - where do we land? Positive or Negative. And take a stab at the value if you wish too. Just leave your guesses in the comments. Feel free to leave your analysis as well. I think it may be helpful for other readers to hear comments from posters. Here are a couple charts for some perspective.

Daily Chart

Weekly Chart

Have a Great Day!

Dave Johnson

I had a nice intraday trade today also, but from a different perspective. Going into today, I was 100% long in my swing portfolio and own a few NQ’s from another system I run. I was late getting into work today because I had some errands to run. I got in about an hour into the trading day and saw everything up huge. Since we’re in a volatile environment and these morning rallies are prone to failing and we were near a “whoosh” point, I saw an opportunity to hedge a little of my profits. Therefore, I went short the S&P 500 (shown on chart). This was not a 10 minute trade, it was designed to protect some of my morning profits. With these type of trades, I hope they’re losers. I hope everything keeps going up and I cover it at a loss. I intentionally hedge for far less than I am long and of a less volatile instrument so if it turns into a +3% day, I’ll still be up 80% of that.

After a few hours when things did start to fall apart, I saw that same double tent stakes that Dave did and covered. Notice that I was nowhere near the low nor was I trying to be. The only way these hedge trades are profitable is to actually cover them at a profit. After my cover, we went lower and then rebounded strong in the afternoon leading to unrealized gains in my long positions as well as a realized gain in my short position.

I apologize for having to steal Dave’s chart, but mine are messed up from missing the first hour.

- John

Earlier today before the release of the Fed Minutes at 2:00 EST I had made a rare intraday post to point to an oddity that had occurred on my 500 tick SP Futures chart (the ES). I like this chart because it makes turning points and flag edges quite clear to me on a longer term basis in order for me to time my entries on the shorter timeframes.

Anyway, this printed a pretty double “tent stake” - so named for their sharp bottoms and broad tops, an inverse of their brethren the “church steeple” top (hammers more appropriately). We had a decent rally off those and then after the Fed Minutes we printed more of these long wicks on the candles. Now if you trade intraday and especially on emotional big down days, any break of these long wick candles can spell trouble. Your typical breakout play that can certainly gather steam.

But if that emotional level is punctured and very quickly pops back up trapping those that played the breakout the fuel for a quick pop and potentially more is in place. That is exactly what we had happen today. The support of the long wicks were broken and the very quickly reversed. But the clincher was the volume in that reversal.

I drew in the emotional break down line. You can see that red candle (key bar) that punctures below the lows and closes below the obvious support level (naked close). This brought in massive trade size and which now sets me to watching the top of that bar as well as the emotional line. Remember breakout players played short below that level. As what typically happens when the breakout fails a quick snapback occurs with some follow through that takes out the emotional level as well as the key bars high (reversal).
So we have printed tons of reversals and ultimately print the clincher naked close reversal. Now what happens after the pop? We begin to trail back lower. But look at that volume as she rolls back. Nada. Shorts/Sellers flat out ran out of gas. I especially like these Naked Close Reversals to be on big volume and in key support and resistance areas. The volume should be the tell if it is.

In this case the ensuing rally pounced upon the lack of sellers and found a key support area for a very large advance into the close.

One more trading day until Turkey Time. If I don’t post before then….Have a Great Night and a Glorious Holiday!

Dave Johnson

We just printed a double bottom with a pattern I really like. See those hammers or “tent stakes” as I call them? Very solid pattern going into the Fed Minutes release. I have a long off of it. We’ll see how much support it provides for the rest of the day.

In my post 2 weeks ago about the large drop in the banking sector I had made a few comments as to what I thought this drop might mean going forward. I had used a hypothetical holding period of 10 days to see what sort of forward results we could see. I also think it shows quite succinctly the power of backtesting.

Here is what I said 2 weeks ago:

Over the next 2 weeks I expect to see what our small snippet of history has shown us.

• Massive volatility in the market and banking in particular
• A tendency towards a upward reaction after a panic low is put in
• I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks

All of these “predictions” were not based on opinion or my personal bias, but were based on what the market had done on average in the past when this condition triggered.

Here is the chart showing that post 2 week period. The blue dot shows the trigger day and the bands denote the high to low range after that period:

Let us review each of the statements.

“Massive volatility in the market and banking in particular” - although most would have thought this statement to be an obvious one it actually was not. If you look at high volatility periods in general these spikes tend to see a lessening in ATR (Average True Range) in periods that follow. Yet we saw an increase in the 10 day ATR for the SP-500 jump 24% and in the BIX.X a 41% increase.

“A tendency towards a upward reaction after a panic low is put in” - on November 7th we had a 6.8% drop in the BIX.X, the largest one day drop in the sector since the selloff began in February and the 8% upward reaction after that massive down day within 4 days.

“I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks” again this was pointing to volatility but also zeroed in on just how volatile. The average for the periods I tested was for post trigger range of over 10% and so I tried to be a bit conservative yet still give an idea of the magnitude of the potential 10 day range. We ended up with an 11.73% range - right on in terms of the historical norm.

This little example gives us a snapshot of the power of backtesting data. It not only gives me trade ideas and how I can frame them but also can give a broader view of what the context of the broader market might be. I would highly recommend you find some way to test and analyze past market data in order to make educated guesses at forward looking market analysis.

Have a Great Week! A shortened one at that!

Dave Johnson

I received some questions today if todays big up move confirms the long entry in the SP-500. It does not. Remember the entry is an up day with volume greater than the previous 21 days. We had an up day but volume was not even close.

Could be tough in the short term to overcome that big volume bar from 4 days ago. But hey who knows.

Have a Great Night!

Dave Johnson

I have a feeling E-Trade’s customers may have another idea for that finger after today…..

Brigbox was correct in choosing the last date we had a 1% up day with volume higher than the previous 22 days. It happened on November 4th, 2004. That is right 2004. Quite an oddity considering the frequency at which they have shown up in the past.

In the comments from the last post you can see what other readers chose as well.

Congrats Brigbox and thanks everyone for playing along.

Have a Great Day!

Dave Johnson

In doing some research to show that not all high volume reversals are the same (one’s after fear are better) I came across a stat that just blew me away. I scanned for days with volume being greater than the previous 22 trading days and the day was up greater than 1% from the previous days close in the SP-500.

Since 1966 we have had at least 160 days that this happened or about 8 times per year. A fairly common event. As a matter of fact we have had at least one happen every year since 1966 without any years skipped. Well not every year. As a matter of fact we have not had one happen in a while.

Here is my challenge to you. Can you find that day for me? The last trigger in the SP-500? Put it in the comments if you find it. If I do not get an answer today I will post the stunning answer tonight. The first to get it correct gets my copy of “There Must Be A Pony In Here Somewhere” by Kara Swisher about the AOL - Time Warner debacle.

Have a Great Day!

Dave Johnson

With the recent protracted slide in the financial sector many market observers have noted how this could be a sign of worse things to come for the limping market. In last weeks post I noted how a slide on the magnitude of 16% in the course of only 20 days pointed to a wild ride ahead.

The sector has slid more this week and I wanted to update the stats and present you with a trade that I think is setting up. We now have that same S&P Banking Index down 18% in 24 days as of the close on Wednesday. This has only happened on only 6 other occasions since 1983. Truly a noteworthy occurrence. As I reviewed the charts of the periods that triggered this condition I noticed that at times the SP-500 was in sync with the weakness in the Banking Index and at times only mildly so. One thing that generally happened fairly soon after this big drop in the Bank Index was a high volume reversal in the SP-500. I defined the high volume as the highest volume in the previous month and happening on a positive closing day.

If I were to test this condition (highest volume up day) on its own the resulting pop tends to be quite unimpressive but if this high volume pop up is preceded by the large banking drop the results are huge.

As I had mentioned an 18% drop in 24 days has only occurred on 6 separate dates that I have listed below.

The dates listed are the day after a close below the 18% level. If after this date we begin to look at the SP-500 chart and look for a reversal as defined by an up day on volume greater than all days in the previous month (21 days we’ll use) we would look to go long the next day at the market on the SP-500. We are going to look for a target in the 4-5% range.

Below you will find all of the charts of the SP-500 with the trigger date listed, the reversal day noted, and the profit target area were looking to hit. In each of these cases the target was hit very quickly even after entering after the large up move. The second entry date listed in 1998 actually happened while waiting for the earlier date to trigger a buy so we will only see 1 historical chart below for the 1998 entry.

This chart above of the 1998 entry shows our exit hitting in less than 2 weeks.

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Again the entry in 1999 above hits our target in only 11 trading days.

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The 2001 trade above hit out target in just over a week.

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In this the first of two 2002 entries our target is attained in only 2-3 days.

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In this second entry of 2002 we again hit our target area in just a few days.

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On average we see the large volume reversal entry day within 12 days after the large drop condition triggers. 1999 was the one that took much longer. All the others happened very quickly.

On average, our target area is hit in about 5-6 trading days. Think about that a 4-5% upside move in the SP-500 in 5 days.

Based upon this analysis I will be on the lookout for the high volume upward punch that will catch the shorts covering and those with limited equity exposure trying to catch the ride. As for me it is a trade. Nothing more. After my exit the markets can tank all they want. All I am doing here is trying to frame a trade. In terms of a stop - based on this historical snapshot I’d say a stop in the 7% area should allow enough room for the trade to work.

Keep your eyes peeled because if we get it. I won’t miss it.

Have a Great Weekend!

Dave Johnson

All week on financial television and media I have heard how volatile the market has been. All I can do is pull from SenatorLloyd Benson’s famous quote and say “Nasdaq today you are no Nasdaq of yesteryear”

I am in no way implying about future movement but those were spectacular moves. That you had to have been through to truly have a concept of massive moves.

Also this weekend I will be doing a follow up on my Bank index post from last week. And pointing to a specific trade that could provide a huge opportunity in the near future.

Have a Great Weekend!

Dave Johnson

I’m sure some of you have noticed I haven’t been posting as much recently, the primary reason is I haven’t really had anything to say.  Take today for example, it was your pretty typical large down day.  Both Dave and I have made posts alluding to the impending volatility (Stormy Seas,  Bank Index Drop).  We’ve also mentioned time and time again of managing your overall exposure, by using strength to sell into so when there is weakness, you have the opportunity of having capital to deploy.

All you can do during these times is cut back on any margin and keep following your systems.  As expected, my personal account and our swing portfolio are both in similar drawdowns.  However, you’ll notice that our swing account is up ~18% versus less than 5% for the same time frame of the S&P 500.  That is by all accounts an excellent year.

Could the market go down more tomorrow?  Absolutely.  Could it go down the rest of the year causing our swing portfolio to end the year with a loss (albeit most likely far less than the market), sure it could.  Am I worried about either of these scenarios?  Not at all.  Dave and I have spent thousands of hours testing and refining our systems and are extremely confident in their long term ability to outperform the market.  A 10%, 15%, or even 25-30% drawdown is not going change that.  The key is these systems work long term. Long term is not daily, weekly, or even monthly.

- John

The SP Bank (BIX–X) index has dropped 16% in the last 20 trading days and I wanted to test what sort of market action has happened after this magnitude of a decline. Since 1993 this has happened on 7 occasions.

In my test I bought the bank index the first open following the 16% drop in 20 days and sold in 10 days. Simple. On average that index has shown random 10 day holding periods to change in price on average about +0.39% . After this condition has triggered the average 10 day move has been about +5.07%. Wow massive. The volatility coming into this period tends to continue. If you look in the last 2 columns in the spreadsheet within the graphic you can see MAE% and MFE%. These represent Max Favorable Excursion and Max Adverse Excursion. This shows us how high (favorable) and low (adverse) price deviated within the 10 day holding period.

August 28, 1998 had the largest adverse excursion of 13.1% and ultimately finished 5% negative after the 10 day period. These periods are very volatile periods for the market as a whole and point to underlying concerns with growth and interest rate direction.

Over the next 2 weeks I expect to see what our small snippet of history has shown us.

• Massive volatility in the market and banking in particular
• A tendency towards a upward reaction after a panic low is put in
• I would expect the range in the Bank Index to have a range of >7% low to high over the next 2 weeks

Have a Great Night (and next couple weeks)!

Dave Johnson