Friday, February 25, 2011

Going higher

The most interesting chart today was this one, the daily VIX. Recall how a few days ago I said that the VIX rarely continues to climb after gapping up to its upper Bollinger band. I was one day early as it turns out. Yesterday the VIX managed one more push higher. Today it made another attempt at its 200 day moving average but that was rejected too. Even more importantly, the resulting candle was a classic dark cloud cover. That is a strong reversal signal.

Now recall my recent post on Monday about how the VIX can predict the market. Today the VIX peaked and started going back down while both the Dow and the S&P continued their declines for the third straight day. I did a cross-covariance on the VIX that seemed to suggest that when the VIX peaks, the market will turn around within a day or two.

So the VIX seems to be saying that the market is ready to go higher either tomorrow or the next day. Supporting this is that the recent downturn has taken all of the indicators off their highly overbought conditions to oversold conditions. In fact, they are all a lot more oversold than they were after the last big dump on January 28th.

Add to all of this that all three futures are up significantly right now (1 AM EST), the ES and YM in particular both being up 0.42% with the NQ even higher, and I'm fairly confident in saying we're due to go higher tomorrow. Of course, the big caveat here has to do with Libya. If Col. K. does something really outrageous (though its hard to imagine him acting any more outrageous than he already is), that will definitely trump the technicals.


Today I took a speculative flyer in a company called Windstream (WIN). It took a beating recently but seems to have found a bottom and received an analyst upgrade two days ago. Greatly decreased selling volume seems to indicate that we're running out of sellers at this level. Its 8.14% dividend doesn't hurt either. We'll see if this does anything. I'm in at 12.22; it closed at 12.29.

Thursday, February 24, 2011

Libya Runs the Market

Well, I guess I might as well cancel my subscription to eSignal now. Charts no longer seem to matter in this market. All anyone seems to care about anymore is the demented rantings of some psychopath on the shores of Tripoli. Bottom line, the market's not going to go up until Kolonel Khadafi Kalls it Kwits.

Technically, we've entered a swing downtrend, since today's further 107 point drop in the Dow provided a bearish signal. Accordingly, I'm putting up the red arrow. I was wrong yesterday about a turn-around today. Call me an eternal optimist, but after today's further rise in the VIX, it would be highly unusual for it to continue higher still tomorrow. The VIX also hit its 200 day moving average today and backed off it. The Dow is also near its very strong support level at 12,000, and the S&P is close it its own 1300 support. All of this is making me leery of going short here. And I note that all three futures are actually up right now (2 AM EST) for a change.

But like I said in the beginning, Wall St., uh I mean Benghazi St. only seems to care about one thing now. Yes, Libya's oil output is in danger. Libya produces all of 2% of the world's oil. A good part of that goes to France and Italy. It's not the end of the world, folks. The real problem now I'm afraid is that the same speculators who brought us $147 oil back in the summer of 2008 are back to the table to stuff their pockets some more, probably with the same eventual results, unfortunately.

In the meantime, we have our Fearless Leader in Washington boldly issuing Stern Warnings to Colonel Klink to the effect that "you ought not do that". Oh gosh, I'm sure he is just shaking in his boots. Mr. President, you are supposedly the leader of this nation. This might be a good time to exhibit some actual leadership, you know what I'm saying?

Wednesday, February 23, 2011

Recovery possible

Yesterday, in a post entitled "Not looking good for tomorrow", I wrote
"I am definitely reaching for my short hat."
Well the short hat fit quite nicely today, although you certainly didn't need to be Carnac to see this one coming. Today's ugly 178 point dump in the Dow was a market forecaster's lollypop. And while painful, it was probably a good thing as it helped let a bit of air out of the balloon that was pumping up a bit too fast. It makes absolutely no sense for the Dow to be up seven percent after just 35 sessions this year. That sort of gain is obviously unsustainable.

So where next? Today, I bring you the daily chart not of the Dow, but of the YM futures, because I think they hold the key to tomorrow. Since it's already 1 AM, the rightmost candle is Wednesday's. It looks to me like we're replaying the action of January 28th, the last big drop we had in the Dow. And the next day we were up. That looks to be getting ready to happen again. Right now, all three futures are up by about a third of a percent.

I think today's decline was really overblown, driven more by angry mobs in Libya than any real economic basis. Indeed, the two pieces of economic news that came out today were better than expected, but the market was having none of it. I'm guessing that tomorrow, cooler heads will prevail.

I also want to show you this picture of the daily VIX, since I was just talking about it yesterday, and also because this chart is so dramatic:It's not often you see the VIX gap up in a big way from the center of its Bollinger band range, actually opening at the upper BB and then closing even higher. Looking back through the history, it appears that every time that happens (and it isn't often), the next day the VIX goes lower. And that of course means the market turns higher.

So if we do go lower tomorrow, I'll have to start a new descending RTC and put up the red swing trend arrow. Otherwise, I'm taking my short hat off and reaching for my long hat now.


No trades today. I'm kicking myself for once again failing to capitalize on the short side, but the carnage was mostly over in the first two minutes of trading right out of the gate, and that's just not my style. So I just had to take the heat and wait for things to improve, which there is no doubt will happen. However, I think I'm going to start experimenting with taking a short position in ES the night before the next time this sort of situation presents itself.

Monday, February 21, 2011

Not looking good for tomorrow

The Stock Traders Alamanc has two warnings for us right now: "End of February Miserable in Recent Years" and "Dow Down 9 of Last 12" for the coming week.

And right now, that sure seems to be the way it's shaping up. The futures are all down by more than I've seen in a while. The ES and NQ are both down over one and a quarter percent right now (1:20 AM EST), a very significant drop. The last time they were this bad was on January 28th, the day we took a 160 point dump in the Dow. And we have extra guidance from the futures since they've been trading for one day longer than usual with the markets being closed for a holiday. They were also down in yesterday's trading.

And with renewed unrest in the Middle East, this time Libya, things are not looking good for tomorrow morning. However, until we see a new trend develop in the Dow, the "X" trend end symbol stays in place. But I am definitely reaching for my short hat.

Trading Goals for 2011

Well I guess I might as well post my trading goals for 2011 before 2011 is over. It's hard to believe it's almost the end of February already. Like I always say, time flies whether you're having fun or not.

Every serious trader needs goals. If you don't have any goals, you're just not serious. But they have to be good goals. Bad goals are worse than none. When I first started trading, I had some really awful goals. The worst one was probably the one where I was going to make money every single day. Of course, that's just not feasible. Naturally, I failed to meet that goal, which resulted in frustration, which negativelt affected my performance, blah blah vicious circle etc.

I think I've gotten better at it. So here without further ado, is what I hope to accomplish this year.

1. Performance: I'd like to at least match the results I've posted the last two years, being at least a 30% annual return on capital.

2. Size: I want to increase my trading size. This is the only way to get richer without taking on additional risk (meaning the risk associated with investment type).

3. Strategy: I want to make fewer Stupid Trades. These are generally caused by lousy entry points. I need to analyze my entires more closely before pulling the trigger.

4. Diversification: No, not investing in different sectors. I want to explore different types of trading. Arbitrage is one thing I'd particularly like to learn more about this year.

That's about it. That's enough. I'm doing well on some of my earlier goals, which at one point or another included simpler things like "not losing money", "beating the Dow", "keeping a trading journal", and "not beating myself up for not meeting goals".

Can the VIX Really Predict the Market?

The VIX as a market predictor?

There was an interesting article in a few days ago, here: Although the main theme was on why the market's been on such a tear lately, there was an interesting digression in the comments about the VIX and whether or not it has any predictive powers as far as the market is concerned.

Now many people, myself included, do use the VIX to try to get a handle on future market moves. And I've found it to be quite useful, but I thought it was time to put the issue to the test, Mythbusters-style. So I decided to crank up Matlab and do a little math.

The Experiment

I started by collecting closing daily values of the Dow, the S&P, and the VIX, going back to 12/11/09. That's 300 sessions. I chose that number because that was all I could get eSignal to cough up. There's no obvious way I can see to tell it I want more data.

In any case, I thought that doing a cross-covariance of the VIX with the Dow or S&P might prove revealing. Let's start off with the raw data. Here's the S&P (in blue) and the Dow (in red) from 12/11/09 to 2/18/11. I divided the Dow numbers by 10 so both plots would display nicely on the same graph. (Click on the image for a larger version)They look pretty similar, right? Basically what you'd expect.

Now let's do a simple cross-covariance on these two datasets just to get a feel of what the xcov function looks like. Recall that the cross-covariance is just the cross-correlation function of two sequences with their means removed. Imagine having both graphs printed on transparencies and sliding one past the other looking for points where they either line up or don't. That's what the x-axis shows here - how far away from their starting position the two graphs are.Pretty much what you'd expect, right? There's maximum correlation between the Dow and the S&P right in the middle, which represents the zero-lag point. As you slide one past the other in either direction, the correlation decreases, and it does it symmetrically. So - nothing to see here. The Dow cannot predict the S&P, and vice-versa.

Right about here, I'm having nightmares about some savant working for Goldman Sachs in a big room surrounded by racks of massively parallel supercomputers laughing at my puny efforts, but bear with me. It's new to me, at least.

Now let's take a look at the VIX for the same period:Kind of looks like an inverse of the markets, right? Which it should. When the VIX is up, the market is down and vice-versa.

The $64,000 question is, how often, if ever, does the VIX go up the day before the market goes down? So let's do the cross-covariance of the VIX with the market.

Here's the result using the S&P:Hmmm, very interesting. First of all, as expected, the zero lag spot (the middle of the x axis), has a big spike downward, illustrating how the VIX is highly negatively correlated with the market (VIX up, market down & vice versa). But now, focus both left and right of the center line. Notice how, unlike the xcor of the Dow with the S&P, here the left and right halves to the graph are decidedly asymmetrical. There is predictive power here.

To make this a bit more clear, let's try an example with two really simple data sets. a is just [1 2 3 4 5 6 7 8 9 10 9 8 7 6 5 4 3 2 1]. b is [2 3 4 5 6 7 8 9 10 9 8 7 6 5 4 3 2 1 2]. Ie. b is the same thing as a, but it peaks one position sooner (one day if you will). This means that b can be used as a predictor for a. When b peaks, you know a will peak the next day. Here they are in a graph.Now let's plot the cross-covariance of a and b.If a and b were identical, ie. completely correlated, they would have no predictive power and the graph would be symmetrical about the center of the y-axis. Not so here. Note that a and b are identical except that b peaks one day earlier. From day 9 to 10, b is falling while a is still rising. In every other spot, both a and b rise and fall together. This one discrepancy can be seen as the asymmetry in the curve. This is exactly what we see in the VIX cross-correlation. Let's zoom in on it.Note that the slope of every day to the right of the center of the graph (point 300) is lower than that on the left. This represents places where the VIX has changed direction before the S&P.

Let's check this on the actual data. Here's the last 11 days of the S&P, with the corresponding VIX overlaid in red. The y-axis numbers are S&P prices. The VIX values have been scaled to look nice.Here we see that the VIX rose from the 4th to the 8th where it peaked. Meanwhile the S&P was also rising, but it peaked on the 8th, then declined on the 9th. The VIX peaked one day before the S&P!

Then the VIX bottomed on the 11th and started rising. Meanwhile the S&P peaked on the 14th, one day later! It certainly appears that there's something to this.

Which brings us to the dreaded right-hand edge of the chart. We see that the VIX peaked on last Wednesday, the 16th. It fell Thursday and Friday. Meanwhile the S&P has been rising since the 15th. Watch for the next VIX bottom. Let's see what the S&P does the next day.


Of course, this is just a tiny sample, but it sure looks promising. So what's the bottom line? It definitely appears that the VIX can be used to predict the short-term movement of the market. This leaves the questions of how much, how well, and what other outside influences might exist, but this post is long enough. That will have to wait for Part Two.