Bonds....the Fourth Quarter Trade of 2014

If you have been paying close attention to the stock market, market internals/breadth, and bonds for the past three months, you’ve likely come to the same conclusion that I have.

The US stock market is showing signs of severe weakness with the market breadth and leading indicators pointing to a sharp correction for stock prices.

With fewer stocks trading above their 50 and 200 day moving averages each week, while the broad market S&P 500 index continues to rising, this bearish divergence is a red flag for long term investors.

When a handful of large-cap stocks are the only things propelling the stock market higher while the majority of small-cap stocks are falling you should keep new position sizes smaller than normal and start moving your protective stops up to lock in gains/reduce losses in case the market rolls over sooner than later.

Small cap stocks are typically a leading indicator of the broad market. The Russell 2000 index is what investors should keep a close eye on because it’s the index of small-cap stocks. Since March of this year, the Russell 2000 been trading sideways and actually making new lows. This tells us that big money speculative traders are rotating out of the stock market and into other investments like high dividend paying stocks, blue chips, and likely bonds.

Looking at the chart below I have overlaid the S&P 500 index and the price of bonds. History has a way of repeating itself; although it may never feel the same and the economy may be different, price action of investments have the tendency to repeat.

In 2011 we saw the stock market and bonds form specific patterns. These patterns clearly show that money was rotating out of the stock market and into bonds. During times of uncertainty in the stocks market money has the tendency to move into bonds, as they are known as a safe haven. Bonds tend to reverse before the stock market does, so if you have never tracked the price chart of bonds before, then you should start.



From late 2013 until now bonds and the stock market have repeated the same price patterns from 2011. If history is going to repeat itself, which the technical and statistical analysis is also favoring, we should see the stock market correct 18% to 30% in the near future. If this happens bonds will rally to new highs.

It’s important to realize the chart above is weekly. Each candle represents five trading days, and four candles represents one month. So while this chart points to an imminent selloff from a visual standpoint, keep in mind this could take 2 to 3 months to unfold or longer. The market always has a way of dragging things out. If the market can’t shake you out, it will wait you out.

So if you are short the market or planning to short the market be very cautious as it could be choppy for the next several weeks and possibly months before price truly breaks down and we see price freefall.

To get my pre-market video analysis each day, and trade alerts visit: www.the gold and oil guy

Chris Vermeulen
Founder of Technical Traders

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SP500, Russell 2K, Dollar Index and Gold’s – Fake out or Shakeout?

 From The Technical Traders.......

Today has been quite a trading session with risk assets rocketing higher after Mario Draghi of the European Central Bank reiterated what has already been stated. The S&P 500 Index (SPX) is posting some nice gains, but price has not taken out the recent ascending trendline illustrated in the daily chart of SPX shown below. Until that ascending trendline is taken out, the bears remain in control of the price action.

S&P 500 Index (SPX) Daily Chart

Today’s rally has certainly served to work off short term oversold conditions. With the first GDP estimate for the 2nd Quarter scheduled for tomorrow things could get interesting. In the meantime, the closing price today is key. My expectation is that we will not see the S&P 500 Index push back above the ascending trendline today. For the price action to flip back bullish, we need a much stronger than expected GDP result tomorrow.

Another key daily chart which helps provide support that the bears remain in control of the price action is the Russell 2000 Index (RUT). The RUT has given back roughly 50% of its entire move and at this point has failed to even regain the 200 period moving average on the daily chart. Price action would need to climb over 20 points to simply backtest the breakdown level illustrated below.

Russell 2000 Index (RUT) Daily Chart

As long as the RUT holds below the key rising trendline, the bulls must be questioned. However, should the S&P 500 Index and the RUT push back above the ascending trendlines on their daily charts I will become much more constructive regarding the short to intermediate time frames for risk assets.

The other key chart of the day can be found no further than the U.S. Dollar Index futures. The U.S. Dollar Index futures absolutely collapsed today and move all the way down to test the 50 period moving average on the daily chart. So far, the short-term rising trendline has offered support along with the 50 period moving average and the Dollar has bounced sharply higher.

U.S. Dollar Index Futures Daily Chart

As long as price holds above the short-term rising trendline, the Dollar will be able to continue to push higher from this level. Should a breakdown occur we have even more support below around the $81 price level. After a move this strong, it could take days and maybe even weeks for the Dollar to regain its footing. However, the forthcoming Federal Reserve announcement next week will likely seal the Dollar’s fate.

Gold and silver futures are both trading nicely higher on the session in light of the weaker Dollar. However, both precious metals have faded later today as the Dollar started to drift back to the upside. Gold and silver are trying to breakout, but we need to see some continuation before I intend to get involved.

Gold Futures Daily Chart

Sometimes weak breakouts in price action can lead to ugly reversals. I’m not suggesting that a failed breakout will occur in gold and silver futures, but I remain cautious as the breakout so far does not have me totally convinced. Volume in silver is not spiking like it should be and gold volume is also weak considering the possibility that major breakouts are taking place.  Another element that is simply not confirming with strong price action or volume is the gold miners. On a day like today, all that they can muster is a relatively small gain on super light volume. Caution is warranted!

Oil futures are also not shooting considerably higher even though the Dollar remains under pressure. To me, today seems like it could be a misdirection day based on the price action and lack of volume we are seeing to the upside in hard assets like gold, silver, and oil. In addition, volume in the major equity indices and futures is super light. For now, I am going to remain cautious and will likely look to avoid taking on any major risk until the dust settles on the GDP number and the Fed’s future decision. Sometimes sitting in cash is not so bad after all!

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Have The Small Cap Stocks Bottomed Yet?

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The IWM ETF represents the Russell 2000 small cap growth index. This ETF peaked at 84.66 this spring and has fallen in the the 74′s before the recent two day bounce. What we are looking at is a possible 5 wave rally from October into March, and now a possible 3 wave correction (Wave 2) of 38-50% of that entire 5 wave rally.  Elliott Wave theory is broken down into 5 wave and 3 wave movements in the markets and individual stocks, where a full 5 wave pattern in a Bull market is obviously bullish and a 3 wave pattern corrective of the prior 5 wave rally.

The small cap index peaked with the reset of the market in March of this year, interestingly about 3 years into the Bull Market. The first low so far was a  typical 38% fibonacci retracement of the rally from October through early March.  The next low pivot would be a 50% pullback.  This would place the IWM target around 72.10 plus minus some pennies.

In the 72′s that would represent a C wave decline that is equivalent to 161% of the A wave decline in the chart below from the 84.66 highs. ABC declines are common in a Bull cycle and are designed to throw investors off the back of the Bull. Normally the C wave is where investors finally throw in the towel near the bottom, as we saw in early October of 2011.  I wrote an article on October 3rd last year, one day before the bottom outlining why a massive rally was about to ensue.  Will we see the same thing now?

Well, this correction could indicate one more possible decline of 4-5% worst case should this projection in the chart below fulfill.

That said, the 38% retracement we have had so far would also qualify as a Wave 2 low last Friday. Therefore, this outline is to give you some indications of what to watch in case we drop further and pierce those lows.  If we can hold this rally and rebound smartly again, then the C wave of the ABC is likely over and we can get an all clear to be more aggressive.

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Is The SP 500 About to Stage a Multi Month Rally?

J.W. Jones of Options Trading Signals tells us where he sees this market headed...... 

The S&P 500 must have taken notice of the multitude of headlines coming at market participants and proceeded on a path of pure chaos. Since October 4th, the S&P 500 Index (SPX) managed to trade in a range that spanned from 1,074 to as high as 1,171 in 4 days. To put the past 4 days price action into perspective, the S&P 500 Index rallied 97 points or 9% in less than 96 hours.

Since late July, market participants have been dealing with a whipsaw that has been wrought with headline risk coming from Europe and huge swings in the price action of the volatility index. A few short days ago I was calling for a bounce higher in the SPX as every time frame was oversold. After the jobs number came out Friday morning domestic equities rallied sharply higher and in the short term prices were excessively overbought prompting some profit taking.

Around lunch time the news wires broke that Spain and Italy had their sovereign debt downgraded by Fitch Ratings. The downgrade put U.S. banks under pressure quickly and the price action started to rollover. By the end of the day price action was starting to work higher but a sharp selloff played out in the final 30 minutes of the session putting the major indices back into the red at the closing bell. So the real question that lies ahead is where do we go from here?

There is no easy answer to that question as the headline risk coming out of Europe over the weekend could have a dramatic impact on prices on Monday. Just as a reminder, U.S. bond markets will be closed on Monday for Columbus Day, but equities markets will be open as usual. At this point in time my short term bias is to the downside.

It would be healthy to see the S&P 500 roll over here and find a key support level where buyers step in and support prices. A higher low would be constructive and could lead to a more prolonged intermediate term rally which could last into the holiday season. However, before we can see any sort of rally we need to see a bottom form. While I do believe we have initiated that process, until I see a higher low carved out on the daily chart I will consider the current price structure to remain bearish.

In order to break to new lows, the SPX would have to push through several layers of support. I am of the opinion that we are unlikely to see the recent lows broken, but the chart below illustrates the key support levels going forward. A test of the 1,040 – 1,050 price range remains possible, but the price action the past week makes it seem less likely. Within the context of a hyper volatile period of time, just about any possible outcome remains feasible. The daily chart of the SPX below illustrates key support levels for the index:

In addition to the weak price action into the close on Friday, several other clues are pointing to potentially lower prices in the near future. Members of my service know that I focus daily on several underlying ETF’s which help me get a grasp of the overall market conditions. On Friday, the financials (XLF), the Dow Jones Transportation Index (IYT), and the Russell 2000 Index (IWM) all showed relative weakness against the S&P 500. The chart below illustrates the relative performance on Friday:

The financials and the Dow Jones Transportation Index are excellent sectors to monitor when trying to determine the future price action of the S&P 500. Most of the trading session on Friday the financials (XLF) were exhibiting relative weakness versus the S&P 500 Index. Later in the session, the Dow Jones Transportation Index (IYT) started to roll over as well and once both ETF’s were under pressure it was not long before the S&P 500 Index flipped the switch to the downside.

The financials (XLF), the Russell 2000 (IWM), and the Dow Jones Transports (IYT) all put in large reversal candlesticks on the daily chart by the close of business on Friday. This is an ominous signal that lower prices for domestic equities may be forthcoming. The fact that key sectors are showing signs of weakness is a negative omen for the S&P 500 and the early part of next week. However, there is a bright side to this scenario.

If support levels can hold up prices next week and we see a higher low on the daily chart form, the bottoming process could be underway which could lead to a strong rally into year end. Obviously a probe to new lows is possible, but I believe that we are in the beginning stages of forming a bottom and a base for a rally to take shape.

If support levels hold up prices, a bottoming formation will likely get carved out on the daily chart of the SPX. The chart below illustrates two potential outcomes that could cause prices to rally sharply. In one case, a higher low is formed and we see prices take off to the upside. The other scenario involves an intraday selloff down to the 1,040 – 1,050 price level that gets snapped back up and a huge reversal candlestick would be formed. These scenarios are common during bottoming processes. The daily chart of the S&P 500 Index is shown below with the two scenarios highlighted:

The other scenarios would involve prices blowing through support and possibly knifing down to test the S&P 500 1,000 – 1,008 support area. While I find this scenario to be less likely at this time, anything could happen in this trading environment.

The key in the short run is the utilization of defined risk through the use of stop orders. In addition, a trading plan with stop orders and profit taking levels planned ahead will help remove emotion in a volatile tape. The price action is wild, but from my perch the likely scenarios all involve some short term selling pressure. If my analysis is right, this could be a huge turning point for price action the rest of the year.

The next few weeks are going to provide us with clues about the rest of 2011. 

The question traders should really be asking is whether support will hold, or will we break below the recent lows? Right now, the upside looks limited, but in this trading environment the best thought out plans can turn out to be useless if price action does not cooperate. Be nimble and define your risk, as volatility is not likely to subside anytime soon.

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The Latest Options Trading Signals Articles

SP 500 Being Left Behind By The Russell 2000

Before discussing why I think the S&P 500 may be setting up to rally I have to discuss an options strategy that often times is overlooked. Besides writing covered calls and cash secured naked puts (same risk profile by the way), one of the most basic spread constructions available to option traders is the vertical spread.

A vertical spread can be written when an option trader believes prices are going up (bull call spread) or when prices are going down (bear put spread). In addition to the previous trades which are placed as debit trades, option traders also have the ability to place vertical credit spreads too. While vertical spreads regardless of nature are a very basic option trading strategy, they can produce strong returns with defined risk.

A brief description of a vertical debit spread involves buying a call or put and simultaneously selling a strike further away from the money. Vertical debit spreads always have a directional bias depending on whether calls or puts or used. The sale of the call or put that is further away from the money results in a credit and helps reduce the total cost of the spread thereby reducing the capital risk. A call debit spread, also called a bull call spread is used when a trader expects higher prices. A put debit spread, also called a bear put spread is utilized when the option trader expects lower prices.

A vertical credit spread is established in the opposite construction of a vertical debit spread. The construction involves selling a call or put that is closer to the money and buying a strike that is further away from the money. This strategy profits from time decay as well as price action. The maximum gain is limited to the difference in the credit received for the contract that is sold and the debited premium that is required to purchase the long strike. Vertical credit spreads always result in a trader receiving a credit. A call credit spread, also known as a bear call spread is used when an option trader is expecting lower prices. A put credit spread, also known as a bull put spread is utilized when an option trader expects higher prices.

I typically use vertical debit spreads when I want to place a trade that has defined risk and when I am expecting an underlying’s price action to move in a specific direction. However, vertical credit spreads are often overlooked by many traders and this is most certainly a mistake. My favorite time to utilize a vertical credit spread is when price action across the equity indices is ugly. In fact, a nasty selloff where implied volatility is juiced in most equities presents an outstanding opportunity to construct vertical credit spreads.

With the commodity complex getting hammered recently as the U.S. Dollar increased in value, a lot of the agriculture based companies have suffered. The ETF MOO as an example has lost close to 10% from recent highs. I was stalking $MOO looking for a bottom in the price action and on May 23 I looked on as MOO was close to testing its 200 period moving average shown below:

I had also been stalking Deere & Company (DE) for a while looking for a bottom. As it turns out, $DE is the single largest individual holding held in the MOO ETF. When I saw MOO bounce near its 200 period moving average while at the same time I looked on as $DE closed in on its 200 period moving average I felt that we were near a short to intermediate term bottom in the agriculture space. I immediately looked at the $DE option chain as well as the historical implied volatility chart. The trade offered solid risk definition as the 200 period moving average was my support level and credit spreads offer an option trader precise capital risk attributes.

Since Deere & Company had been under significant selling pressure implied volatility was elevated which would also put the wind at my back. When writing credit spreads, implied volatility is critical and must be monitored. I knew I was selling juiced option premium as the implied volatility was historically elevated. The closest at the money strike on the put side was the June DE 80 Put contract. I proceeded to sell the June DE 80 Put contracts and bought the June DE 77.50 Put contracts in a 1:1 ratio to setup the spread.

The maximum risk per put credit spread was $197. The maximum gain was $53 per spread. At expiration the maximum yield would be earned if $DE closed at $80/share or more. The maximum yield of the trade would be 27% (53 / 197) based on maximum risk. The profitability curve of the DE Put Credit Spread is shown below:

I had absolutely no intention of holding this trade to expiration. In fact, my trading plan was to close the trade as soon as a 15% return based on max risk was reached. I employed a hard stop based on the underlying Deere & Company stock price of $80.90 /share. Essentially the trade had a 1:1 risk versus reward ratio (also referred to by traders as a 1R trade). I entered the trade and at this point still have the trade open, but with the higher prices I am seeing this morning (Friday) in $DE, I will be closing my trade with a gain near 15% of my maximum risk and 100% of my hard stop based risk.

Often times option traders overlook basic trading strategies like a vertical credit spread. In a stock market correction or in a situation where a particular underlying has been under selling pressure for quite some time and implied volatility is juiced and a major support/resistance level is nearby, vertical credit spreads offer solid risk / reward. Often times option traders fail to use basic strategies like vertical spreads which provide them the opportunity to trade around bounces, topping patterns, and bottoming patterns without the total capital risk associated with buying/shorting stock.

Russell 2000 Index (IWM)

Members of the service I run are used to seeing analysis about the Russell 2000 Index on a daily basis. Every day I monitor the price action in the Russell 2000 Index (IWM), the Dow Jones Transportation Index (IYT), and the financial complex (XLF). Quite often one, if not all of these ETF’s start throwing off clues about Mr. Market’s favored market direction.

During strong moves in the market, all 3 ETF’s will generally be moving in the same direction regardless of whether prices are going up or down. If the move is strong and has momentum they all move the same way, but generally speaking one of the ETF’s displays relative strength against the S&P 500 and the other ETF’s.

Recently the Russell 2000 Index started showing signs of life and then the transports and financials followed the small caps higher. While both the Transports (IYT) and financials (XLF) traded higher the past two days, neither have had the relative strength that the Russell 2000 ETF (IWM) has shown. When the small caps speak, I listen and they have been screaming the past two days that higher prices may be likely next week and into the first week of June. However, as the daily chart of IWM below illustrates, they have some major work to do the rest of Friday and next week.

If the price action in IWM can push above the upper bound of the recent downtrend and show continuation higher, we will likely watch as the S&P 500 pushes up to the key 1340 price level for a retest. If the S&P 500 is able to penetrate the resistance area I believe we will likely see the 1,400 – 1,450 S&P price level come into play. The daily chart of the S&P 500 Index (SPX) is shown below:

I am leaning bullish on the S&P 500 and risk assets in general (commodities) going into the final week of May and the early part of June. I am expecting a news event to move the markets in a big way within the first few weeks of June. My guess is that an announcement coming out of Europe will be the headline that finally pushes the market into overdrive. For right now, the price action is coiled and we are about to witness a big move.

While I am leaning bullish, I am certainly not willing to risk capital in an attempt to game price action. I will sit back and wait for price action to confirm and pick my spots. Anticipatory trades do not fit my risk tolerance or trading style and I consider them sophisticated gambling. I’m going to let others do the heavy lifting and wait for confirmation about the trend’s direction. At this point in time, the small caps are signaling that higher prices are likely for equities but the real question is whether Mr. Market is just toying with us and this is nothing more than a head fake. Risk is excruciatingly high.

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