Friday lower

The Hoot 
Actionable ideas for the busy trader delivered daily right up front

• Friday lower, low confidence.
• ES pivot 1827.33.  Holding below is bearish.
• Next week bias uncertain.
• Monthly outlook: bias lower.
• ES Fantasy Trader standing aside

Recap

Finally, I got one right. My call for Thursday lower played out, as well as my reading of every individual chart I looked at.  But we will avoid committing too much hubris here and simply move on to Friday.

[Note: the Blogspot spell checker is on strike again tonight, so I apologize in advance for any typos.]

The technicals (daily)

The Dow: Last night I wrote "there's more downside to come on Thursday." and did it ever come - down 176 points for its worst one-day loss since last August.  That broke support at 16,263, completed the bearish stochastic crossover, and busted through the lower BB but did not drive the indicators oversold yet.  So we might still see some more selling on Friday.

The VIX:  Last night I wrote that the VIX "now at least seems to be wanting to move higher" and on Thursday it put in an unusal gap-up gravestone doji that just touched its 200 day MA before retreating.  Although the indicators ar enot yet overbought, this is bearish for Friday.

Market index futures: Tonight all three futures are lower at 12:42 AM EST with ES down by 0.14%. Last night I noted congestion in ES and wrote "we may be setting up for a move lower out of this range" and that's just what happened on Thursday with ES taking a decsive dump to send the indicators lower.  And with some negative pin action in the overnight, the selling may not be over yet.

ES daily pivot: Tonight the pivot drops from 1838.83  to 1827.33.  We remain below, so this indicator remains bearish.

Dollar index: I didn't call the dollar last night, which was good because I sure didn't see a one percent drop coming on Thursday.  This big gap-down marubozu took the indicators off overbought and broke a couple of support levels.  But with this big gap, a DCB isn't out of the question on Friday..

Euro: Last night I wrote "the euro is ready to move higher" and boy did it ever, up a whopping 1.11% on Thursday to blast right out of its descending RTC and clear past resistance at 1.3515.  And even that wasn't enough to drive the indicators overbought.  But after such a big move, I'd expect a pause on Friday.

Transportation: Last night I wrote "more upside is not out of the question" here and indeed we got another 0.28% out of the trans on Thursday as the bullish divergence continued.  But now it's hard to say.  With the indicators pretty overbought and the trans clinging to their upper BB, we don't have a reversal candle, but a move lower could come at any time.

Accuracy (daily calls):

Month    right  wrong  no call  conditional  batting   Dow
                                             average  points
January    2      8      5           0       0.200     -224

     And the winner is...

I don't know - after such a big move down, it's tempting to call for a DCB, but with all the charts continuing to look bearish, I'm afraid I'm just going to have to call Friday lower.  See you again Sunday night.

ES Fantasy Trader

Portfolio stats:  the account continues the new year at $100,000 as we wait for the right moment to enter our first trade of 2014.

Thursday higher if ES pivot holds

The Hoot 
Actionable ideas for the busy trader delivered daily right up front

• Thursday higher if ES pivot holds, else lower.
  
• ES pivot 1685.67.  Holding above is bullish.
• Friday bias uncertain technically.
• Monthly outlook: bias higher.
• ES Fantasy Trader standing aside.

Recap

ES, 9/11/13, 5 minute bars

Wednesday was a textbook example of how a conditional call works (click on chart to enlarge).  Note how ES wandered around above the pivot  (black horizontal line) in the wee hours until 10:20 AM when the bears marshaled their forces to take a stab at punching under.  This is right in the crucial mid-morning do-or-die area


That failed.  The following candle shows another attempt but this time on much lower volume.  That failed too.  And that's all it took.  After that it was just up, up and away, and the market closed higher.  This trick doesn't always work, but when it does it's pretty cool.

The pivot point is so important.  This is just one of many, many things I learned about trading from reading Dr. Brett Steenbarger's wonderful TraderFeed blog.

9/11

And also, let us not forget that today is 9/11, a date that like December 7, 1941, will live in infamy.  And let us further not forget that while the original perpetrators of this dastardly act of cowardice may be dead and gone now, their evil beliefs, driven by a religion of unspeakable hatred, mindless bigotry and intolerance, live on.  Just a word of warning...

So now let's truck on to Thursday and make some money. 

The technicals (daily)

The Dow: So the Dow has now given us a three white soldiers, and a bullish-enough pattern, though it did hit its upper BB at 15,300 and then some on Wednesday.  RSI is now very overbought at 92.25 but the stochastic crossover is taking its time in forming a bearish crossover.  We remain solidly in a rising RTC and until I see some more stars align, I can't call this chart lower yet.

The VIX:  Last night I wrote "This chart overall continues to look bearish" and I'm glad I did because on Wednesday the VIX fell another 4.89% on a big red marubozu.  That 200 day MA break gets 'em every time.  So this keeps us well within the falling RTC and with no support until 13.50, there remains at least a bit of room to run lower here.  NB - the lower BB isn't until 13.19.

Market index futures: Tonight all three futures are mixed at 12:47 AM EDT with ES down by 0.04%, YM down 0.03% but NQ up 0.04%.  So we're basically flat, which is less positive than we've been at this hour the past few nights.  That said, ES has now given us a bullish three white soldiers like the Dow, remains in a rising RTC, and also hit its upper BB at 1688 (which also happens to be a resistance line) on Wednesday.  Indicators are now overbought to near the point of being broken, ie. losing their predictive power.  So the overall gestalt of this chart remains bullish, but the incipient failure of the overnight to follow through makes me think we're running low on gas about now.

ES daily pivot: Tonight the pivot rises once again from 1678.25  to 1685.67. Just like last night, we were above all day and remain above the new pivot even with this jump but again just about by the same small amount.  So the same observations hold: this remains bullish until ES dives under the pivot.

Dollar index: Last night like the VIX I wrote "this chart continues to look bearish", and just like the VIX, I"m glad I wrote that too as the dollar slid .0.36% on Wednesday.  The indicators continue to fall, we're now in a steeply descending RTC and there's no support til 55.56 (remember, this is $USDUPX).  So I see no sign of a turn-around on this chart tonight.

Euro: After Tuesday's bullish RTC trigger, Wednesday delivered the payoff as the euro piled on more gains to fiish at 1.3310.  Indicators are now oversold but not overly so, and a new rising RTC is intact.  So in the absence of any bearish signs, I'd have to say we could see further gains here on Thursday.

Transportation: In a perhaps telling bit of divergence, the trans gained just 0.03% on Wednesday to the Dow's big 0.89%.  And they did it on a hanging man.  And RSI is highly overbought at 97.6 now.  And we closed above the upper BB.  And we popped out the left side of the rising RTC, an unusual move that sometimes presages a pullback.  All that's missing is a bearish stochastic crossover but right now the bull case for the trans is getting pretty weak.


Accuracy (daily calls):

Month     right wrong  no call  conditional  batting   Dow
                                             average  points

January    5      7      6           3        0.533   -101
February   3      4      5           6        0.692    131
March      5      7      5           2        0.500    121
April      7      5      5           3        0.667    328
May        3      4      6           4        0.636     85
June       6      5      6           0        0.545    543
July      10      2      4           4        0.875    486
August    11      3      6           2        0.813    687
September  4      0      1           1        1.000    270

     And the winner is...

When the basic technicals start giving reversal warnings but nothing happens, I like to go check out my other favorite charts: the NYSE Hi-Lo index and the AD line.  And right now the Hi-Lo is stuck on 100, so no reversal sign there.  And the AD line has been putting in higher highs and lower lows for seven sessions now, so no reversal there either.  And Thursday is historically quite bullish.  Finally, the Morningstar Fair Value index now stands at 1.02, overvalued to be sure, but still below dangerously high levels that precede breaks lower.

But because we have just now hit some resistance lines and Bollinger bands, and because the futures seem to be petering out in the overnight so far, I'm a bit wary of making an out and out bullish call.  On the other hand, the bear case is still not particularly strong.  So given all this and the proximity of ES to its pivot and the similarity of the situation to last night, I'm just going to make another conditional call - same rules: if ES manages to stay above its pivot of 1685.67 by mid-morning Thursday, we close higher.  But if it breaks under decisively before then, then we close lower.

ES Fantasy Trader

Portfolio stats: the account remains at $108,500 after 15 trades (11 for 15  total, 6 for 6 longs, 5 for 9 short) starting from $100,000 on 1/1/13.  Tonight we continue to stand aside.

Does rising oil make the market fall?

OK, now that I've gotten my oil rant out of my system, it's time to take a more analytical look at the situation. I'm going to do the same thing I did with the VIX last month - look for correlations between the market and the price of oil. Does rising oil really make the market go down? Let's see. First of all, here's a chart of crude oil futures (the CL M1) in red, for the last 300 days, 12/18/09 through 3/4/11 alongside the Dow (in blue). The Dow values have been divided by 1000 to make them scale nicely. At first glance, it sure looks like there's actually a high positive correlation between the market and the price of oil. Oil up, market up, and vice versa.

Now let's do a cross covariance of oil and the Dow. Yup, pretty much what you'd expect from looking at the raw data. There is actually a strong positive correlation in the sample period between the price of oil and the price of the market. Here's the chart. Recall that the halfway point of the x-axis represents the point in time where both charts are completely lined up.

Now let's do the same thing, but on just this past month of trading. Here are the last 20 days of the Dow vs. CL. Whoa! Almost the exact opposite. Ignoring the slope of the curve for the moment, we see that what we have here is a high negative correlation: oil up, market down, and vice-versa. So sometimes oil and the market correlate but other times they don't. It might be useful to know when this flip-flop happens.

So I ran the 20 day correlation in a loop, testing every 20 day (one trading month) period from 12/28/09 to today, and then plotted the result of each correlation, ie. how well oil and the market correlated for every 20 day period.The results are interesting. We can see that over the course of the last year, oil and the markets have pretty much moved together, though by varying degrees.

The greatest correlation came in the 20 day period beginning 4/30/10. After that, oil started to become generally less correlated with the market but at no time did it exhibit an inverse correlation (except for two dips just below zero). Until just under two months ago: January 21st of this year. After that, oil and the markets started moving in opposite directions, and the trend has been getting constantly larger ever since. Ie., the more oil goes up, the more the market goes down.

Unfortunately, this all seems to raise more questions than it answers. Why should oil suddenly reverse its correlation with the markets around the end of January? I tried poking around the news archives around that time but didn't find anything particuliarly significant. The unrest in Tunisia was already going on at that time, but it was a month later than when it all started. And why the big spike in positive correlation at the end of April 2010? Quite frankly, I have no clue.

It might be worth revisiting this to see what happens when oil and the markets go back into positive correlation. I wish I had a better conclusion than this, but it's still pretty interesting. Perhaps the main lesson here is that rising oil is never necessarily always either good or bad for the market. And whatever relationship it has is subject to change in a non-random fashion.

Can the VIX Really Predict the Market?

The VIX as a market predictor?

There was an interesting article in www.seekingalpha.com a few days ago, here: http://seekingalpha.com/article/252838-4-reasons-the-stock-market-has-doubled?source=tracking_email#comment-1481460. 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.

Conclusion

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.