Twisted Markets

Still trying to make sense out of the current volatility? You're not alone. Some of the most savvy and experienced traders are hard pressed to find order in this market. A few have attempted to formulate a game plan, and Larry Connor's recent post is worth a look. I have followed Larry for years, before he became the main man at TradingMarkets.com. His early statistical analysis works on trading, including Advanced Trading Strategies and How Markets Really Work, are great baselines for understanding the basic nature of the markets and have provided the foundation for many system traders. Much of the info on TM is subscriber/fee based, but there is also lots of free stuff, including the commentaries.

VIX hammer

Regarding my little WMIH trade, looks like the 37.50s were the place to be, not the 40s. Nevertheless, that was a good 3 day play and I will close the trade, wait for WM to rebound some, and then probably sell the 37.50s. The financials are getting slammed again......

The big breakout this AM turned out to to be a bust and I sold ATM Sept. calls twice as the Qs approached 47.80. Seems like I'm in good company as Clueless found a similar trade attractive. The Qs finished with a short doji, and although up for the day, are not looking all that cheery on the lowest volume in 2 weeks.

My consideration that the Qs might actually get back to the 49 line is based on the VIX, which has now retreated from wildly overbought territory to just overbought. While my first reaction is to play a return to the 10DSMA within a day or 2, the VIX has been like a cobra in the bag lately ... every time you think things have quieted down and look in the bag, it spits in your eye.
Based on the newly resolving BB pattern I am inclined to think that 20 might be the new 10 for some time to come (when and if it ever gets down to that level). As always, caution is advised. Check the Vix and More sidebar on the right for typical expiration week dynamics, although this doesn't quite qualify as a "typical week"

WAMU (WM): An option pricing lesson

Above are the 1 & 2 day 10 minute charts of WM and the 1 day 1 minute chart. The 2 day chart shows where WM opened and closed on Friday relative to Thursday.

My goal was to sell some of the Sept. 40 calls (WMIH), to pick up some premium. Based on the fundamental weakness (and perceived risk) in the financial sector, the odds of WM rebounding above 40 in the next 5 weeks appears slim (this is my opinion, only .. see disclaimer sidebar).

At Thursday's close WMIH was trading 75/85. I had hoped to get a pop up on Friday, but the frogs got loose and as we all know Friday's open was frightful.

WMIH opened 50/70 Friday. We got an S2 bottom kiss at 9:42am (34.52), then reversed at 9:50 and climbed to 36.00 by 10:08am, where WM formed a squat bar for the next twelve minutes. I know the market makers like to play this thing .. one favorite game being to lift the ask just before reversing down.

At 10:15 WMIH was 75/85, so I entered a Sell order at .90 (just trying to play the game, as we had been squatting for 8 minutes and were due for a turn).

The spread went 80/90 at 10:17 as WM hit 36.04. I adjusted my price to .85 and got a quick fill, and the spread immediately dropped to 75/85. I decided to sell some more if I could get my price and entered a new .85 order.

Over the next couple hours WM slowly climbed to 36.45, but my order sat unfilled as the spread actually declined to 70/80.

WM got a quick sell off 12:30-12:50 with the spread 65/80.

For the next 1/2 hour WM climbed up again and at 1:38pm, with WM @ 36.22 and the spread 75/85 I dropped my Sell order to .80 and was filled at 13:43 with WM @ 36.00. Now that was weird .. the price went down,but the option went up.

Over the next hour WM retraced back to S1 (35.64) with a 60/65 spread.

For the final 90 minutes WM again climbed to make the high of the day (36.53) at 3:35, with the spread 65/75.

WM then sank to 36.00 at final close with the spread 60-65. Final adjusted close was 35.75 so the adjusted spread is probably 55/60.

Bottom line. .. I managed to sell the WMIH close to my target relative to the market. The market makers have a bad habit of changing the volatility value on a whim, with resultant option spreads to fit their pricing models. Many times these pricing models are difficult to decipher or to foresee ... which is what makes trading complicated (see previous post for attitude adjustment tool). I suspect we will see the value of WMIH decline rapidly for the next week, regardless of WM's performance. My experience is that calls tend to be relatively expensive the week before expiration and relatively cheap the week following expiration. This is part of the market maker game to make rollovers a bit more expensive for you. At the same time, mid-expiration spreads are typically smaller than either the week before or week after expiration.

VIX means volatility

For those traders who are feeling a bit battle weary, confused, dazed and/or paralyzed at the trigger, I have included a nifty little attitude adjustment tool to help you regain your otherwise finely tuned trading brain functions. I have personally used it recently (and frequently) with some success.

As foreseen by everyone with a globex feed, the markets opened with a thud today and the VIX promptly popped up to 29.84 in the first 18 minutes, giving up some ground around midday and then running around 29 for most of the afternoon session. VIX and More has some interesting insights on today's VIX action and Bill helps explain how the VIX could stay elevated in the face of a rising market. For those (like me) whose lives center around watching 2 minute bars develop, there were definitely some strange divergences between the VIX, TRIT and NYAD bars, which are normally closely correlated in a binary fashion. I suspect at least a portion of this squirrelly behavior was the product of option market makers setting up for expiration week and on Saturday I'll post an in depth look at how this little game played out in WM (luckily I had my handy head banging tool close by).

The Qs actually held up pretty well after the overnight tumble and stomach churning first hour. The 3/7 DSMA was a touch, but not a cross, so I am still net long my big Qs position, now hedged 30% @ 46, 50% @ 47 and 20% at 48. I don't intend to load up on any more of these prior to expiration and am waiting to see how the current doji resolves. (Same EOD pattern for Qs and VIX). The tactical buying cutoff was really Tuesday .. after that theta accelerated, (regardless of the VIX) and each subsequent day until expiration is progressively less attractive due to the diminishing payoff. For now, I'm in a holding pattern.

VIX at new high

Just when you thought it was safe to go back into the water, this happens. Above is me (donut) and Mr. Market (Jaws).

That "one problem" I mentioned yesterday turned out to be a real doozie. The volume that was missing yesterday was back with a vengeance today and it was all selling.

The 3/7 DSMA cross is on the verge of recrossing as the Qs closed 10% below the 5o DSMA, although relative to the rest of the market the Qs held up well until the close, when it collaspsed on high after hours volume.

The VIX was the story today, with a 3 point gap up at the open, then clawing up to a new intraday high to close right at the upper bollinger band, while showing of no signs of being overbought and the MACD histogram now above the zero line.

Technically, these indicators do not bode well for the market and the globex is extremely negative (-1000)+ at 9pm pst. We may get a drop and pop at the open, or we may just get a big drop, so extreme caution is advised tomorrow. Given the unpleasant news that has been popping up lately and the market aversion to the associated risk, we may see an afternoon sell off as traders opt to fore go weekend news and unpleasant surprises by exiting the markets.

VIX hits 20 DSMA

Two positive indicators today.

The Qs 3/7 DSMA cross was solidly up, confirming our buy signal yesterday. With the pullback in the last hour, we are now set up to continue the rally tomorrow.

The VIX came down to the 20 DMSA precisely. I was surprised that it happened so quickly, but the VIX is now showing a complete rollover with the MACD histogram advancing below the zero line. Again, the close was not at the lows, so the setup is for further VIX decline, with the 16 range possible, but the 18 range more likely before a short term retracement.
Carl Futia has some interesting charts today. Take a look. His July 30th post on the domed house pattern was dead on, and he's looking for the next turn around Sept. 15th. This weekend I'll post some VIX studies that support that projection.

One problem is that most observers believe we have seen the bottom (or quick double bottom) and are now headed back to 14,000+. The sustained level of buying today of pretty much everything supports that notion. The TRIT and NYAD both stayed solidly bullish all day, with the exception of that lighting sell off (and you think the markets are random?) so that the generals could run the stops and pick up some cheaper inventory. However, volume today was not exceptional, which suggests that not everyone is buying into this rally. Any bad news, or other perceived excuse, could cause a little panic here if buying dries up and reverses. The wide range days we have seen lately may subside for several days in setup for next week's expected expiration rally.

The Fed Roller Coaster

The usual wild ride following the FOMC announcement not to do anything. Clueless does a fine job of explaining the finer points of this typical swing pattern. It's amazing to me that each time this happens the media and various market types all appear surprised. Imagine the morning newspaper arriving with the headlines - "Nothing New, same old stuff as yesterday" and the market reacting with 100 point swings - you would be amused and otherwise hard pressed to explain what was going on. But there it is, with great regularity, the product of massive program trading, gaming by the generals and panic/greed of the uninitiated.
Another wide range day for the Qs (blame or thank the Fed), closing above the 50 DSMA, and with a touch of the 3/7 DSMA cross -my long signal. With 11 days to expiration I bought Qs, covered 50% with QIDs, rode them up for . 30 and sold the near 47s to lock in 1.5%. If we get continued strength tomorrow, I'll try the same thing with the 48s as my target. I prefer to wait until 2 weeks before expiration prior to putting on these trades as the theta is typically minimal for the first 2 weeks after the prior expiration, relative to the risk.

The VIX has retraced through the 10 DSMA and now looks poise to hit the 20. The MACD histogram is below the zero line and the 5/20 cross is heading down which suggests a solid move up in the markets for a few days. MAYBE. Buckle up.

Rollover?

Qs closed just below the 50 DSMA today after another wide range S1/R1 day.

VIX managed to hit another high today before falling back to approach the 10 DSMA. The wide range R1/S1 bar closed on the low the day, which suggests further downside likely tomorrow.

The TICK, NYAD and TRIT were all upslope the last 2 hours, with no range retracement, although the TICK readings were relatively tame. Whether these indicators reflected sustained short covering or genuine buying interest remains to be seen.

I was prepared to short XLF at the open, but it did not falter in the face of the "loaners" (WM, CFC) decline. The market makers kept the bid/ask spread on the puts at .15-.25, which is not an attractive buying environment. At that point, the markets began showing some strength and I stood back from any notion of shortng (happily).
Carl Futia sees this as the bottom, with new upside targets yet to come. Check out his new guesstimates.

SFO and system trading

If SFO isn't part of your regular reading material, it should be. Consistently high quality articles based around a monthly theme. Many of the articles are available online and a subscription is free. Last month featured some fine articles on the psychology of trading and this month (August) the topic is system trading and auto trading. Even if you prefer discretionary trading, you best be informed about what the rest of the big market players are doing. Keeping in mind that only 7-10% of the daily NYSE volume is retail trading, the 800 lb gorillas in the market (institutions and commercials) are using sophisticated algorithms, neural networks and probabilistic logic , coupled with leading edge computers making nano-second computations and executions to make life difficult for you. This series of articles may provide a little wake-up call for those who don't already appreciate how much the odds are stacked against them. I don't intend to convey a negative message here ... just a realistic one. Forewarned is forearmed.

Free Fall Friday

Heavy selling in the financial sector prompted by a Bear Stearns warning and a poor jobs report drove the markets down in the afternoon session and the usual selling crescendo in the last hour.

The Qs are not oversold at this level and 46.50 looks like the next support.
The VIX has bounced off the 10 DMSA and is headed higher through the upper band and it is not overbought at this level , even after making a new closing high.

The XLFs are suffering the most and the cross of the 50/200 DMSA is a negative sign, coupled with the technicals which indicate XLF is not oversold yet.
The market makers are really having a a field day with the high volatility . . . put spreads, normally seen at .05 are now running .20-.30. Placing limit orders based on intrinsic value is a very risky game at this point with the markets moving so fast and the risk factor is greatly increased by trading wide spread market orders. Not a happy situation.

Qs rally; VIX retraces towards 10 DSMA

Qs rallied up to R1 at the open and modulated in a narrow range for the remainder of the day, never touching another pivot. The entire market went flat line right at noon ... in expectation of another major surge ... either up or down. The NYAD, TICK, TRIT and volume flow all went into a suspended state for about 5 minutes and you could clearly see the quiet in the markets before the breakout . . . which turned out to be a break to the high side. Although the 3/7 MA cross has not yet materialized, the next short term trend for the Qs should be up ... with short term resistance right at 49.00.

The VIX did confirm the 4 day resolution pattern mentioned yesterday, declining precisely to the S2 pivot on the narrowest range seen for the past 5 days. The VIX has now fallen below the MACD (5,20,3) histogram zero line and the 10DSMA @ 20.47 is the next target.

Wild Wednesday

Another nail biter today as the markets set up to presumably follow the late day capitulation selling seen over the past few days. 12:30 approached and, if you were watching the option chains, you saw the offers lift in both the puts and calls without any equity action .... and then, as equities moved forward, the put premiums plunged. Traders had been conditioned like Skinner's rats to expect the late-day sell off, and I suspect there were more than a few transfixed by today's market behavior. Carl Futia has some interesting forecasting charts on the current state of affairs and I think they are worth a look. Today's Qs volume matched last Thursday (318M) and it remains to be seen how much of the 44M shares traded in the final 30 minutes was short covering (the last 10 minute bar of the day had a volume of 15M and a huge range of .48).

The VIX gave a dazzling performance ... climbing through 26 and then free falling almost 3 points to close at the prior high. The VIX is currently in uncharted territory and while there are precedents for these levels, the fact that the VIX remains close to the upper band suggests this cycle is not done. The typical pattern after a solid close above the bands is resolved on the 4th day (today), and although the markets did show impressive gains into the close, the VIX is still in nosebleed territory so caution is advised, as always, prior to initiating anything other than a short term position. Aain the VIX has reverted to NOT overbought status.

I was able to get off several good trades today ... shorting WM and TOL out of the box as the financials and housing continued to deteriorate (wish I'd bought AHM, but I was dinking around with other stuff and missed that swoon to .85), and then covering those shorts at the first turn. Later, as the XLEs began their slide I buy/wrote the near 68s at 68 for a 2.15 premium, which is a good 3% return for 17 days. Look at the 5 minute bar hairy bottom in the XLEs at 12:30 as the XLEs displayed a wide squat bar just below S2. Picture perfect buy setup.

Ugly Tuesday

We got the run up I was looking for, but buying dried up immediately and the sell off continued wih a vengeance into the close. After rising to R1 in thefirst half hour the Qs broke down to and through S1 at 10:45. A hairy bottom pattern in the 5 minute bars suggested a reversal but when the Qs again reversed off S1 (48.08) at 12:30, it was clear that S2 (47.63) was the next target. The Qs have now broken through the 50 DSMA on a high volume, engulfing, wide range, close low bar and although badly oversold, show no indications of reversing to the upside. The selloff in other sectors really was as bad as it looked, with the financials getting especially hammered.

The VIX also shows no signs of reversing, having displayed today a similar pattern of Thursday, with the current difference that, after Monday's run-up, the VIX is not overbought.

I'm finding it difficult to implement my usual options stategy as the market makers are sucking the premium out of both the puts andthe calls at a dazzling rate, perhaps as a tactic to handicap the straddle players. I am therefore moving to the QIDs, long and short, for my intraday trades until this situation improves.

Qs bounce; VIX fades: will it hold?

The Qs performed as expected today. After an inital pop at the open, the Qs retreated to the 50 day SMA and then inched up for the rest of the day.

The VIX also performed as expected. After the close high, wide range bar Friday, the VIX today showed a close low, wide range bar, falling back through the upper bollinger band.

Premium decay today was was exceptionally high, with both puts and calls losing value as the market modulated. I"m not sure whether this was a strictly a function of the volatility decline in the VIX or gaming by the market makers, but it was dramatic (an frustrating).
The current pattern typically shows another dip before any meaningful further move up (big question...how big??) and based on past VIX behavior the best guesstimate is up Tuesday, then down Wednesday for the Qs. I typically swing trade this Qs pattern based on a 3 bar/7 bar DSMA crossover. The current chart shows little inkling for such a crossover and I will hold on any new longs until such a crossover occurs.

VIX tops out: Qs hit 50 day MA

I closed my Qs calls this am on the initial pop-up for a net gain of zero. Ditto on the IWMs except I took a .03 loss due to volatility adjustments by the market makers.

The VIX showed the wide range, high close bar on a parabolic curve that I was expecting. At the same time the Qs displayed a wide range, close low bar right at the 50 day MA. Qs volume today was the highest since February 27th and with 7 down days on increasing volume the Qs may be ready for a breather. However,with a closing TICK of -680 and all technicals deteriorating, expect more downside follow-through to precede any turnround on Monday.

Clueless has examined the data on a weekly timeframe, and that scenario looks a lot more iffy. Take a look.

Qs back to support; VIX blows up

Well that was interesting. I unloaded my overnight Qs puts a little too soon this morning, thereby missing the huge downside gains I would have otherwise enjoyed. However, I did get to spend most of the day at the dentist, ultimately ending up with a root canal. Not quite sure which experience was the most painful . . missing the market or seeing the dentist.

Qs about at 50 day MA, which they haven't seen for a while . . but that was a touch, not a close, so we may see more selling before a real reversal.

The VIX went off the charts today and is now looking seriously overbought. I couldn't' find a pattern that quite matches the current one (help . . anyone), but VIX reversals typically occur at

long, close/high bars, so the multiple falling hammers that keep creeping up has me suspicious.

The portfolio is still 80% cash although I did initiate a long call position in the IWM and Qs towards the end of the day (although my judgment was pretty clouded as a result of the extreme jaw pain I was suffering at the time).

Are we done yet?

The DOW lurched forward today, driven by MRK, BA, IBM and XOM. Otherwise, no impetus.

After an opening pop and drop, IWM finally came alive at noon, and surged up to close just off the PP pivot and the zero line and now looks poised to drop again.

The Qs almost made it to 49.70 (49.67) before ratcheting down, then up, then down, then up .. finally closing up .05 on a downslope -20 TICK and an upslope .77 TRIT just below the PP pivot.

The VIX put on quite a show, rolling below S1 at the open and then screaming strainght up through R1 to top out at 19.46 in the next 50 minutes and VixandMore posted a BUY equities post.. The VIX then cylced between R1 and PP for the rest of the day, closing at 18.09.

I buckled up for the ride early on and managed to get in 2 good IWM trades (UP) and 2 good Qs trades (down) with a .01 loss on the 3rd Qs trade when I got stopped out just ahead of the pop (of course!), thereby missing a nice .06 profit in the next 10 minutes.

As mentioned yesterday, the current VIX pattern is not familiar and suggests more room to go.

Qs plummet; VIX shows teeth

The VIX broke through the upper band and is now precisely where it was a month ago. Looking back to July 10(not a band break), June 26 and June 7 we see band breaks and moves more than 10% above the 10 day SMA typically display impressive next day reversals and quickly revert back to the 10 day SMA. VIX and MORE thinks things may be different this tme.

The Qs blew though initial support at 49.70 and had the highest volume day since June 7. After 4 down days the odds are building for a reversion pop-up to 49.70, which probably will not hold . I don't think we will get a repeat of the June 7 scenario.

The portfolio is now 80% cash.

Qs stall; VIX in overbought range

The Qs never got far off the PP pivot on Monday. The TRIT flatlined between PP and S1 and both the TICK and the NYAD remained downslope all day. Yes, the Dow was up 92.34 but that was driven by 4 stocks: MRK, IBM, PG and XOM. For a Monday, this was not a strong day and based on the charts, I think the the Qs are going down to support at the 49.70 level before resuming any uptrend. Although the VIX is banging agaist the upper band and the spinning top suggests a reversal (down), I think we'll see a solid break of the band before that event. This could happen quickly, but one day pattern reversals favor Wednesday or Thursday as a best candidates. I'm holding back on new premium decay plays until I find some attractive setups.

Monday Series: Part 4 - Improving the Odds

Some traders learn from their mistakes ........ others never recover. Trading is an adaptive, dynamic process that is filled with risk and uncertainty. Those who fail to adequately recognize this simple truth are in for rough ride. Contrary to popular myth, there is no holy grail trading system. Consistent trading is about a state of mind and Dr. Brett Steenbarger over at Traderfeed tries to impress that truism unto his readers every day. I know many successful traders and frankly, no two trade alike ..... everyone is wired a little differently as a result of either nature or nuture. Whether you favor gap fades, momentum stocks, late day breakouts, new highs/new lows, moving average crossovers, algorithmic trading, neural networks, probabilistic statistics, etc., the trick is to make the system your own, to understand every nuance of the system and to meticulously define, test and follow the rules of the trading plan within which the system, or systems will be used. Here's another spin on the same topic and it's worth a close read:
http://www.chrisperruna.com/2007/07/11/the-holy-grail-of-trading-its-not-your-system/

Other intervening factors can contribute to trading outcomes, and traders need to avoid using them as crutches in the face of both good and bad results. Case in point: Charles Kirk has an excellent post on the role of luck in trading. Basically, you make your own luck through proper due diligence, positive attitude and systematic trade execution. There's no free lunch in the market. For the full text, see:
http://www.thekirkreport.com/2007/03/get_more_lucky.html

There are many free sites that provide trading algorithm testing, both forward and backward. Several of the sites have their own programmable rating systems to enable traders to rank stocks based on a variety of technical and fundamental criteria. Six of my favorites are: http://moneycentral.msn.com/investor/StockRating/srsmain.asp
http://www.powerratings.net/?home=2
http://www.daytradeteam.com/dtt/
http://www.trade-ideas.com/StockInfo/
http://www.tradetrek.com/online.asp

http://www.tradingday.com/

A wide variety of paid sites provide daily statistical and technical perspectives on the market, including timing indicators and signals. Two of the best are:
http://www.markettells.com/
http://www.sentimentrader.com/

I have mentored many traders and in my experience the ones that excel are the ones that think systematically, who have attained the self-disciple and focus to follow a trading plan (remember Curtis Faith from last week?), and who understand that trading is a business .... a serious business for those who seek to make it their livelihood. Successful trading is an incremental process based on precise and methodical risk management. Trading is not a hobby, a casual past time or a gaming proxy. Contrary to the Gordon Gecko persona, good traders also tend to display a profound humbleness, perhaps because they understand the fragile nature of their success. Having been a business owner and operator in my pre trading life, I understand these concepts quite clearly and when I was struggling with my early trading a couple readings of Alexander Elder's "Trading for a Living" brought things back into focus. I hope that some of the resources mentioned here can facilitate your path to consistently successful trading because there' only one thing more painful than learning from experience ....... and that is not learning from experience.