Wednesday, August 10, 2011

VIX foretells cautious optimism for Wednesday

That's what I'm talking about

Yesterday evening (Monday) I wrote
"...the VIX is going lower tomorrow. That should provide the juice to run the market higher."
Well holy moly!  What we got today was more like rocket fuel than mere juice.  And if you recall, yesterday afternoon I wrote about how the pattern the VIX was forming was historically reliably followed by a big market push higher the next day. Well today the VIX crashed 27% and the Dow exploded for an astounding 430 point gainNever discount the predictive power of the VIX.

Actually, while Monday was scary bad, today was scary good. Today I had by far my biggest gain since I started trading in 2003.  I made a full 7%In one day.  I had to blink and look twice at my trading platform  to make sure I was reading the P&L line right.  Of course that was all merely erasing my horrible unrealized losses from Monday, but still it made me glad for not following all the lemmings over the cliff.

ES daily with retracements
The technicals

So is there any gas in the tank left after today's monster move to continue higher tomorrow?  Let's look at the daily ES chart.  I've added the Fibonacci retracements from the July 22nd high.  You can see how we retraced just short of the 0.382 retracement on Tuesday and just about touched it in the evening session.  With such a big move down, I think it's not too much to expect at least a 50% retracement.  That would be to 1214.  Since we're only at 1166.25 at 1:30 AM EDT, there's still considerable upside available there.

Then candlestick-wise, we see that Tuesday's action formed something of a hybrid between a hammer and a piercing pattern, both bullish patterns.

Also, the indicators which had all been lying panting on the floor oversold for days now have come back to life and are starting to rise again.  That's also a bullish sign.

The VIX

Meanwhile, the all-important VIX tumbled a monster 27% today to close at 35.06.  I was expecting a decline but was surprised at the extent of it.  And the candlestick it put in is telling.  This is a black closing marubozu and is quite bearish, suggesting the VIX has lower to go on Wednesday.  Historically, when the VIX takes a big drop off its upper Bollinger band, the next day tends to continue at least a bit lower.  That would imply higher stocks.

The bottom line

Amazingly, it has now been over a month since the Dow managed to go up for more than a single day in a row.  This alone would suggest that tomorrow is more likely to be down than up.  And although I expect an eventual upward retracement of the recent giant crash, common practice suggests a downward retracement of Tuesday's 430 point gain would come first.

And indeed all three market futures are running lower by about 0.25% at 1:30 AM.  That's the bearish case.  So with these mixed messages, which one is the most convincing?  I'm going to have to go with the VIX and make a call for higher stocks again Wednesday, though I'm not expecting anywhere near the move we saw today and I'm not nearly as confident as I was last night.  When the VIX is at these levels, anything can happen.

Trades

Today I dipped my toe in the water, not for my trading account, but for my IRA.  With the VIX still at a crazy high 35, it is too hard for me to find good swing trading entries and exits and I continue to stand aside.  However, for my much longer horizon IRA, today I bought some high quality dividend paying Dow stocks that have taken quite a beating recently: GE at 15.37, Intel (INTC) at 20.08, Home Depot (HD) at 29.45.  I also picked up some AK Steel (AKS) at 8.13, mostly because it was just too cheap to pass up.  AKS ended at 8.60, GE at 16.04, INTC at 20.62, and HD at 30.25.  So that's not too bad for an afternoon's work.

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