Death or Glory?

Well, we had an interesting end to the week, yes?

Seemed, to me at least, that a sell-off has been a long time coming (as I’ve been saying on ye olde Twitter machine). And by long time, I mean a couple months and particularly this last week. My trading time frames are short, and as a futures trader I really couldn’t care less whether the market goes up or down on an intraday basis. But because of my favored time frame, I always have to be aware of what the higher time frame is up to, particularly at the margins. The higher time frame players, also referred to in profiling parlance as other time frame (OTF) players, are the ones whose decisions ultimately move the equities markets.

So what’s their agenda for the US equities this week? Death or glory? Listen to the brilliant song of the same name by the blindingly brilliant band The Clash while you read to get the full effect.

S & P 500

This week’s musical post title is actually a double entendre. Why? Well because not only are we at a clear price/valuation inflection point, we have a rarely seen extreme clash between the so-called smart and dumb money players:


The above chart, from SentimenTrader (yep, I’m a paying subscriber) smart/dumb money model,  shows us that the spread between the optimistic trend-following bulls and the pessimistic “smart guys” is at an multi-year low. This interpretation of this chart can be confusing, despite its apparent simplicity, so it makes sense to let the maker explain it (emphasis mine):

The Confidence Spread subtracts the Dumb Money from the Smart Money.  So when the Spread is very high (above 0.25), that means the Smart Money is looking for a rally, and the Dumb Money is looking for a decline; we should expect stocks to rise after those conditions.

When the Spread is very low (below -0.25) then the Smart Money is anticipating a decline and the Dumb Money a rally; we should expect stocks to decline after that.

Note that the “dumb money” is not dumb at all during trends.  Most of them are trend-followers, and will get more and more bullish as stocks rise.  The “smart money” is mostly comprised of hedgers, and they will sell short as stocks rise.  So for much of the time, it looks like we have the terms confused.

But it is when both sets of traders are at extreme positions that they earn their moniker.  Dumb Money is most often at their most exposed before stocks decline, and at their least exposed before stocks rally; Smart Money is the opposite.

Note that the “dumb money” is not dumb at all during trends.  Most of them are trend-followers, and will get more and more bullish as stocks rise.  The “smart money” is mostly comprised of hedgers, and they will sell short as stocks rise.  So for much of the time, it looks like we have the terms confused.

Since since both groups can’t be right, the most likely outcome in the near term in my view is an increase in volatility. Which would be a most welcome improvement over the lazy trading days of the last few weeks.

As far as what I think is next, I see and am planning for a couple scenarios. It was clear that the dip buyers were active and buying each new low (see candle tails below), which made for a steady, controlled slide rather than a bloody knife drop. Especially so below about 2080, and then a little covering rally at the end of the session:


We also just touched the 50DMA on the SPX, and that is a well-watched landmark:


Since this is the first test we’ve had in weeks, my favored scenario is that we have something of a bounce early in the week. In addition, the ECB QE program starts Monday as well and that could release some loose money in need of a home. My macro view is that the only thing which will raise the prices of the index to new highs at this stage is fresh funds. I’m sticking to my thesis that the lion’s share of the big money is already invested, expecting higher prices and trying to achieve that via the financial media, engaging individual investors’ desire to not miss the boat. That said, we have two distinct areas previous acceptance from the highs down to the top of the low volume area (LVA) at 2085 (see below chart). The lower balance area in particular is within pretty easy reach in one or two lusty buying days.

If instead we see the selling continue the range of prices which is the most plausible the first part of the week, and in most need of short-term repair, is the range from about 2085 to 2040:


However, if this is only the beginning of a significant repricing event the next area is the range from 2040 into the series of open gaps down to around 2015 created during the epic “battle in the box” from January and early February:


Be sure to notice too that the VPOC for this range is right at about 2050, so any drop through there may be slower and more contentious that you might hope for unless we have something akin to a flash crash. Anything can happen, of course, but it’s probably best to just expect the most probable things. If you take my meaning. I’m sure you do, gentle readers.

Any lower than this and I’ll re-calibrate my expectations. Fact is long term trend is still secular, long-term bullish. Friday’s ES 2065 low is a measly 2.5% off the highs. At some point the market will do its job, buyers seeing bargains will step in with force. It’s always pretty obvious when it happens, if you’re open to seeing it.  Whether it’s Monday or in a month, just know it will happen and prepare to capitalize on it.

Oh, and uh, one last thing. Not covering the rude crude (WTI) this week, though I will be watching. We’re in a place where I’m expecting more than enough action in the SPOOs and QQQs to hold my interest and require my full focus. But, as always, I will be watching to see if it throws any fat pitches my way.

Trade ’em well this week, amigos…

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