Saturday, March 17, 2012


There was a nice comment posted in response to Friday's post that I responded to in that thread, but it also made me aware of something that I need to address. When you host a blog like this there are new people coming in all the time and at times they will not go back and read what I have written previously. They will not know if I was bullish or bearish a week or two months ago on something, that I may have a different view on today. There is nothing I can do about this. In the comment I am referencing above it was mentioned that my bearish view on stocks might have influenced him or her. For readers who have been here awhile, you know I was very bullish at the end of last year when most people were not. I showed a trade live where I legged into a position on that nasty decline in November in both the SPY's and some index funds in an IRA I trade. I am long since out of those trades at this point.

When I look at my returns I tend to make about the same amount on both sides of the markets. All traders know that short profits tend to happen faster due to the nature of how markets trade. They tend to be sharper in price and shorter in time. Bull moves tend to stair step upward. This is just a general characteristic of how markets trade. As a result profits on shorts tend to happen faster and the longs tend to take a little longer to develop.

I also often show the COT data, and at times I heavily bash that data. It is important to understand what that data gives us and what it does not. What it does tells us is who is doing what, more or less. Occasionally those brain surgeons at the CFTC give incorrect designations to funds that cause market mishaps. We cannot control this and also will never know it is happening when it does. The only way we can account for it is to realize that reading this report is an art on steroids. It has taken me a very long time to get the hang of this damn thing. However, a very important point needs to be made in regards to this and it is evident in the chart above even though it is not shown. When we get a trend like this, COT data is really of no value at all. They will often just show them selling more and more as prices continue to rise. As traders this is not a sell signal, it is meaningless.

I would argue that even knowing if the Small Specs have their largest short position in history like they do in Unleaded Gas here, is meaningless also. We will be able to go back when a top forms and see that yes they had this position at the time, but how deep are your pockets? Do you really want to short that market right now? I don't! If we were to have a trend break and high test, while that same COT condition exists, that is another story entirely, and that is a trade I would take. It is imperative that the COT report be viewed as a tool, nothing more. It can be a very good one, but like any other tool such as MACD or RSI etc.., you have to know when to listen to it and when not to. This takes time and experience.

With the thought in mind that when I post bigger picture setups, it does not mean I am trading in that direction the next 5 minute bar that shows up, I want to point out a few things on the chart above of the Dow. I have an overlay with the VIX in green on this chart of the DOW, and have drawn a line at the levels in the past where problems have developed. One mistake that people make in using the VIX is looking at absolute levels, they can change over time. What we see in this chart is when the VIX has dropped under 15 in all but one instance, a good sized decline has taken place. You can certainly argue that all of the circumstances with these readings are different, but how complicated to you want to make things? I don't find that type of analysis makes me any money. A number is what it is in my view. What is more important is what you can see on the next chart, what the VIX has done on a relative basis in the short term.

The bands on this chart are just 10 day moving averages plus or minus 10 and 15 percent. You can see when we have closed outside of those bands on the down side, typically a decline has followed. We just did that a few days ago once again. You can see that the recent buy point in the market had a close outside the top band right on the day of the low. I was aware of this at the time but my short term tools did not give my buy signals, so I did not catch this move back up the last two weeks. I also do not have any short term sells yet, so there is nothing for me to do here. However, because of this as well as the larger picture where we are under 15, I have to look to the short side here. I am just looking for a trade, not a world ending wipeout to the down side.

Here is how things look with new highs vs new lows on the NYSE here, again a negative divergence.

Once again you can see that there is some underlying weakness that is not showing in the broader averages readings. The New Highs less New Lows is not advancing and it not in new high ground for this run. This is a negative divergence. You can see in the midst of the heart of this trend price and this index were completely in sync with one another, that is how it should be. The advance/decline line is still very healthy showing new high readings, but from my research New Highs less New Lows is a much better indicator of market turns. Study it yourself and draw your own conclusions. This indicator also does not turn the market on a dime in general, although at the lows on the far left of the chart it certainly did. If you are short term momentum trader, or a day trader, this type of stuff is irrelevant. If you trade like I do where you are looking for where the next likely large swing is going to come from, these types of things are more important.

To sum up my view on this, I see no reason at this point to short the market. I do see some things that are telling me that we could be heading for some trouble, and as a result I am looking for sell signals up here. There are none in sight at this point. In general I don't like to buy markets that are this extended, but if for some reason my short term signals give me buys I will take them. There are no buys close to being there at this point either. I am looking elsewhere for trades right now.

Good Trading

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