A Walkthrough: The Powder Keg Trade

Been a long time since I was able to blog much. But in the words of Jack Nicholson from The Shining, I’m baaaack!

For the last past few weeks on Twitter I’ve been posting a lot about the #powderkeg trade. I’ve tried to explain what it is, why it works, when its most likely to work. But tweets aren’t always the best way to get a series of points across, and I’ve had a ton of questions about it. It’s not practical or possible to explain it each time someone asks about it, so I thought I’d walk through the finer points here.

First, let me go though what it is NOT (in no particular order):

  • The best trade ever. This isn’t a home-run type of trade. If you define it “right” it has small risk and generally good reward. By “good” I mean somewhere between 1 unit of risk for 2-3 units of reward. It’s a solid base hitter, though every now and then it cracks one out of the park.
  • One pattern to rule them all. This trade works best on non-trending days or later in the day when any drives from the opening of the session have exhausted their fuel.

That said, it has a lot of good things going for it (again, in no particular order):

  • It requires minimal tools, though as you’ll see I use a volume profile. VPs will help tremendously in defining the boundaries and quality of the setup. But truth be told this can be done without a profile.
  • It requires minimal preparation.
  • It requires no directional bias (it’ll be better if you suspend all bias, in fact). So in some ways, it’s the ultimate anti-revenge-trading tool (I’ll post about revenge trading another time).
  • No need to catch a falling knife or catch the top tick.
  • Works on pretty much any kind of short duration bar, ones that take 2-5 minutes on average to complete is best. The more bars there are the easier this pattern will be to identify. That said, many Renko bars will work against you here, they are designed to filter out exactly the kind of “chop” we’re after.
  • It’s the same pattern every time (but the quality – the ease with which its recognized – and outcome varies, of course).

Why it Works

Markets ultimately have one purpose:

quote

The theory behind this trade is simple. It works because it’s catching the end of a short-time-frame auction cycle… i.e. balance. Once a market achieves balance (supply/demand equilibrium, fair prices, etc.) on any time frame, its purpose has been fulfilled and it must start the cycle over again (see above). More about balance and other profiling concepts here. We want to be ready and waiting when it starts this cycle anew.

What to Look For

  • Find an area where price stalls, preferably away from a recent area of balance.
  • We want price to have left and returned to this “stall” (balance) area at least once on each side.
NQ - Powderkeg no profile

Example 1 – No Profile

 

NQ - Powderkeg with profile

Example 1 – with Profile

 

Now that we have the basic elements down let’s talk about a few characteristics which sweeten the quality of the setup:

  • The more times price exits and reenters the balance area the more powerful the break. At least one excursion-and-return on each side is needed to validate the setup.
  • The session VPOC’s included inside the balance area. Even better is when the VPOC’s in another location, you identify a new balance area, and before the balance breaks the VPOC moves into your forming balance area. This means volume’s being expended in this area and (probably) that stop loss orders are accumulating on either side of this balance area. These stops will serve to accelerate the move once it finally breaks the balance area.

 

Defining the Risk and Reward

There are multiple ways to do this, but ultimately your risk will be just over or under the center of your balance area. Preferably the highest-volume price in your balance area. Ideally it’s the session VPOC (point of control). You’ll want to define your reward at at least 100% of the size of your balance area. If for whatever reason it seems implausible that your target will be achieved, forget the setup and move on.

Example: if your balance area is 10 points across, your ideal 1st target will be 10 points on either side of the boundary of the balance area. Since you’re defining your risk as mas o menos the center of balance, if you enter at a break of the balance area that puts your risk:reward at ~1:2, assuming you only trade one contract or lot. It gets more a little more complex (but with a more favorable ratio) if you trade multiple lots or contracts because you can scale out along the way, booking profits and reducing your risk, while still having ammunition to take down further moves.

 

NQ - Powderkeg R-R

Example 1 – Reward Zones

 

Once the reward zones are defined, I like to use a trend line to split the balance area in half. There are many ways to split it in half, but I find this helps keep me focused and in the flow. Use whatever works for you.

I use a bottom or a top trend line depending on which way I think the keg will blow. It really doesn’t matter whether you draw the trend sloping bottom left to bottom right or vice versa as long as it splits the middle of the balance area. If price breaks back through the trend line, no matter which way you draw it, you’ll want to get ready to try in that direction. In this case, based on price action, order flow and internals I think this balance is most likely to break to the upside. So that’s how I draw it.

 

NQ - Powderkeg R-R Trend

Trend/Risk Line

Getting In

Now that our risk and reward is defined, how to you know when to get in? What you’re looking for is an impulsive directional bar. You HAVE to be paying attention here. This means any bar that starts to move unusually fast in a direction, compared to other bars nearby. Remember, you’re in a balance area, which is generally slow, lazy “chop.” So a bar that starts to hustle should grab your attention. Ideally, you’ll have your entry order(s) ready to go and all you have to do is place it and let price trade through and thereby assure a good fill. If you can’t get filled on your entry it’s probably because you hesitated and chose a bad price. The best prices are always ones that you can actually get filled. The best way to assure a fill is to make sure your order is one that gets traded through while price is on its way somewhere else.

This “trade-through” strategy is my preference, is entry option A pictured below, and will give the best risk and reward. A more conservative entry is to let the impulsive move happen and then wait for a back-test of the balance area to hold. This is option B. You still have to act decisively, or you’ll blow your R:R. Be quick or be dead, as I say. So shoot to kill.

 

NQ - Powderkeg ENTRY

Example 1 – Entry Options

One of two things will happen at this point, and neither are in your control. First, price will move toward your target and you get ready to book your profits, or price comes back at you and enters your stop zone (see above). If it does it’s OK. It happens. Look at the risk here… if you got long at the impulse through 4400 and your sell stop was at 4396, your target was around 4415… that was a 1:4 trade. You can afford to try again or flip the other direction even twice and still profit on the trade. But you have to honor your stop.

OK, so, how’d this one turn out? As you can see below, the impulsive bar I thought would be the magic one was a head fake. But that’s OK, because our stop was never touched again. Price re-entered the balance area, giving it even more power, and a few minutes later it launched out in our direction all the way to and past the previous day’s high. If you have enough units to scale out along the way, the max favorable excursion (MFE) would have been about 25 points, while the max adverse excursion (MAE) was just 9 ticks.

 

NQ - Powderkeg COMPLETE

Example 1 – Trade Complete

More Examples

Today gave more than its usual share of #powerkeg opportunities. Generally, there’s one or two a day. But today, thy cup overruneth,… so to speak.

 

NQ - Powderkeg EXAMPLES

More Examples – NQ

 

ES - Powderkeg EXAMPLES

More Examples – ES

Hope this was helpful, amigos. Until next time, trade ’em well…

Same Old Situation?

Given the what’s been happening in the US equities markets the last couple weeks I felt it only fitting to honor this week’s post with one of the best worst songs from one of the best worst bands in one of the best worst genres of rock and roll – “Same Old Situation” by Motley Crue. And also they are on their farewell tour this summer. So listen in while you read. If nothing else it’ll put a smile on your face with its ridiculous but nostalgic excess. The same could be said of the state of the markets right now, no?

Here we go…

S & P 500

Well, we got it. Yes, it. The elusive, exclusive initiative buying we needed to push back through the critical 2105-2107 area in the ES that’s been so difficult to break lately. Friday marked the 6th (count em’) attempt above this zone since the 3rd week in April. Of course, the question of the hour is whether it’s different this time. So… is it? What’s changed?

Let’s have a look and see what this week’s COT report says about how the important reportable categories are positioned.  In the ES we see the Asset Manager/Institutional category is long 1,229,592 (change -43K) contracts and short 516,499 (change -22K) contracts with both sides decreasing exposure from 1 week ago.  Levered funds are  422,587 (change -25K) long to 770,747 (change +38K) contracts short, while the “other” category exposure remains net short by more that 2:1.

Interestingly, the asset manager category increased long exposure last week in the big contract by more than 3.5K big S & P contracts while the levered and other categories remain net short the big contract.

So what the takeaway?

I’m thinking here’s really a couple of plausible explanations. First is that there is just plain disagreement between the biggest money and the aggressive money over market direction. If you lay the common narrative over the numbers, the aggressive money thinks the market is over-valued and is trying to get in position for a top. The other plausible explanation is that the increase in short exposure is actually hedging activity for long equity exposure and there is actually a belief new surge of money about come rushing into the market, tsunami style.

To be frank I find the former scenario the most plausible given how the story has unfolded over the last few months. In my view the range-bound sloshing of recent months is most credibly seen as participants disagreeing over the intermediate term market direction and battling to take control of it. But that’s not to say the latter scenario lacks all credibility. I think it does, but of course I have no visibility into what money is lurking on the sidelines and how much is there. But one thing I do know is that now that Q1 earnings season is over, and with interest rates remaining crazy low, there will be buybacks. Starting soon. This self-generated demand is kind of like a snake eating its tail in my view, but it is what it is. I have to account for its potential effects on the market writ large.

So… let’s start with the extremely solid channel built by the ES starting overnight on Thursday:

ES

But when we start looking at the RTH only trading, we can see this march up was not without it’s structural flaws.

ES3

Since we’re focusing on the coming week let’s start with that monster gap up on Friday. Given the RTH volume on Friday (over 1M contracts) it would seem that someone was trying to send a message. There was a massive run of stops overnight Thursday all the way to 2107 and the bids just kept on coming. All day Friday there was selling into this move up, and this can be clearly seen in the order flow, the top bulge of the profile and in just in how compact the up-move was considering the volume.

Given this, my overall plan for the week is to watch for the same-old-same-old or for a significant character change in the tone of the market. Evidence of this change will be seen in a buying appetite for prices over the 2105-07 area. Such a change in tone would represent that buyers are now seeing value in large caps, where they haven’t recently, even so close to the all time highs. This is incredibly bullish, at least in the short term. On the other hand, you’d be crazy in my view not to expect a clean trend up free of the same range-bound sloshing.

So… first and foremost this week I’m going to be on the lookout first for a  more of the same in the form of the kinds of repair shown below. In my plan that would call for at around a 50% retracement of the late week up-march from about 2060 to 2115 should we push back through that all-important 2105 area shown below.

ES2

This half-back area, sitting from about 2090-2083, would be where I’d expect assertive buyers to be found on any push lower. If they liked it above 2105, the same buyers should be ass-over-tea-kettle in love with it at 2085.

If, on the other hand, this push up on Friday was a successful attempt at gaining decisive control of the market direction, I’ll not only be targeting the 2120 area but looking at the area around 2128 and even 2147. I suspect a close above 2120 puts the fear of God in the leveraged shorts (position summarized above) and we may even see some sort of capitulation. With short positioning this high, it could lead to a rampant orgy of new highs.

But let’s not get too excited just yet. As I said, I think there would have to be a significant change in character in the market for this to happen… and I’m pretty sure I’ll know it when I see it.

Beyond this… who knows. I’ll be taking it one day at a time.

Not covering my other markets this week, folks, other projects beckon for time and attention. Trade ’em well this week, amigos…

 

Para el Escenario Número Dos , Marque Ocho

[Translation: for scenario number 2, press 8. Ah the irony.]

We had one hell of a week in equities, didn’t we? Going into it (for me) was a lot like calling the 800 number for the utility company, impatiently trying to wade through the phone tree options to get to the one I want.  As it turned out I had to back all the way out to the top level, stabbing and swearing at the 10-key menu, to get to the trading scenario that ultimately worked.

Last week I felt like the time was more ripe for a significant correction than it’d been some time. But no. It wasn’t to be. That really leaves only two explanations: my thinking was early; or my thinking was wrong. I feel confident enough that I didn’t somehow misread the technical tea leaves.  The charts were pretty clear. But guess what? Buyers wanted to buy despite all the lines and letters I drew on my charts. ;-} I mean, check out the circled region. Sure looked weak at the time, like a slinky about to walk down another step:

ES-Daily1

If you hang out in the Twitter #twitpit you may know that I was actually pretty short the indexes for the first part of the week based on my thesis. But by Wednesday mid day it became pretty clear that the morning’s dip buyers were serious and I unwound the remainder of that position while the unwinding was good.

I could go on and on and on about how as a trader it’s paramount to stay flexible, but I won’t do that. I’ve done it before. Instead I’ll just say that’s why I make 2 plans. I prepare for both success and failure, because when I do that I can easily flip failure back to success.

Anyway, let’s get on with the show…

West Texas Intermediate Crude Oil

That all-important weekly historical chart I posted a while back? Wow, you couldn’t have asked for a better performance. Here it is, exactly the same line and arrow as a few weeks back:

www.tradingview

On the weekly time frame it looks like we’ve had a pretty spectacular and predictable bounce. Zooming in a little close and we see that this week in particular was all about consolidation following an equally spectacular 5 straight weeks of vertical development:

CL
… with the POCs and overall balance remaining stable in the mid 57-58 region. The stable consolidation is even more evident on the daily chart:

CL-VP

… with a clean test of both the mid and top of the regression channel I have from early March. And from a classic TA perspective, this week looks a whole lot like a bull flag in the making, doesn’t it? So for the week ahead my scenario numero uno is for a test of the next balance area above the 58.60s up. The 60 handle is the first natural upside objective as it’s a round number and also because it’s smack in the center of the balance area formed when the bear flag/consolidation zone was created there in December (all prices are relative to the June contract, by the way):

CL-VP2

If this consolidation craps out and rips recent longs a new one below the 55.40s, my scenario numero dos expects to find pretty significant support at the 53-52 region. I mean check out the hot, steamy kurtosis action on the right side composite above. If that’s not profile porn, I don’t know what is. ;-} Anyway, at this stage in the oil saga I’m thinking only force majeure will take us below that 52 handle.

S & P 500 + Goooooooooold!

Oh yeah cowpokes, we’re going to be talking about the SPOOs and the shiny yellow stuff at the same time. Why? Well because gold is a pretty good sentiment indicator. In times of fear, the price goes up. In times of confidence (complacency?), the price tends to go down. Of course, we also know that the gold price “floats” on the price of the currency in which it’s denominated as well. But at this juncture in the equities market I’d rather look at what the price of gold is doing overall, globally, as opposed to how the value of specific currency is affecting it. So let’s start there. In my ideal world, the price of gold and the price of equities should move inversely. I’m not saying I expect them to move in lock step, I’m only saying that in times of market development (such as now) they should be inverse in their directional movement.

GC

Anyway, just like the SPOOs (below), gold has spent the last few weeks in a consolidation box pattern (above):

ES-Weekly

 

… and while the SPOOs have finally (!!!) broken to the upside at the same time gold looks to be starting some downward vertical development. This is exactly the kind of thing I’d like to see for a credible equities rally.

So for gold this week I’m leaning toward a test of the 1155-60 zone, though at this point I’m not really expecting anything lower regardless of what happens in equities. Should that downward development fail to materialize most likely something unexpected and potentially destabilizing has happened in the world macro balance. In that case we could even see a return to the previous zone of the failed auction in the 1215-25 zone. Which brings us back to the SPOOs…

The range breakout this week was a long time coming, of course, and it left a new but significant feature in the 2105 area on both the time (above) and volume (below) charts. This should be considered something of a very short term, intraday line in the sand. Taking a step back, though, it’s very common for the SPOOs to give as much as half of the recent range back before climbing higher.  So I’m pondering 2 scenarios for this week. The first is a slow grind higher, a la your typical week in late July. I think early in the week, Monday especially, chances are very good for some additional upside. Mondays are QE day in the EU which means hot money is spewing forth, and also in the states Mondays are a very common day for long-only mutual funds to average in their buys near the RTH VWAP line.

Beyond Monday I am going to be on the lookout for a punch down the the 2100 area, and I think we could easily see the 95-85 area and still be in rally mode. A quick failure about 05 and a push down to the 85-95 area would likely get enough traders bearish to be caught off guard and provide some buy stop grease for subsequent rally to even higher highs:

ES-Daily

So for this week I’ll be favoring upside scenarios until I see evidence otherwise. The best long trades will likely come at the pullback levels mentioned above. I’m not of the opinion that, at least on a swing timeframe, this move higher is not something I want to chase. But that said, I think the realistic upside targets are around 2125-2130ish, and for the mega bull scenario I can even plausibly see up to the 2145-50 area. Again, this breakout is still very wet behind the ears, naive and vulnerable, so it’s not wise to chase it. Let it prove itself first. Shorting breakdowns of the areas mentioned above and getting long the pullbacks (also highlighted) is the way to play this week in my view. And that’s what I’ll be doing.

Trade ’em well this week, amigos…

 

 

I’m Pretty Tired… I Think I’ll Go Home Now

It’s no secret that’s I’ve been feeling disturbances in the force for some time now. If you look back through my weekly posts (or watch my Twitter feed) you already know I’ve been very skeptical of them moves the markets have been making lately, particularly since the first of the year. Well, amigos, I could very well be wrong (of course) but I think the chickens are coming home to roost. Finally.

To put it simply, it looks and feels to me as if this market is just plain out of gas for the time being and needs a well-deserved correction to revive the will to run any further distance. Said another way, in the immortal words of Forrest Gump when he was at the sudden end of his cross-country run for no particular reason, “I’m pretty tired. I think I’ll go home now.”

S & P 500

Last week I likened the price action of the SPOOs to a Slinky walking its way down the stairs and I was looking to see whether we’d take another step down or spring up on to a new level. As it turned out the Slinky metaphor was right on the money. We rolled over and took a big ‘ol step down just as it looked like we were set to take a step, albeit a tentative one, higher. All 3 of the senior indexes utterly failed to hold the top of their recent trend lines:

spy qqq dia

What’s more, I think the divergence between the SPY and DIA versus the QQQ is the most telling (and damning?). If you look closely, you’ll see that the big caps were actually doing a better job at testing highs than the QQQ. Which is exactly the opposite of what I’d expect from a market with prices being driven higher by future growth and earnings prospects. Here’s a closer look:

ESvsNQ

Note the difference between the channel slopes between the ES and NQ. Again, this is exactly the opposite of what I’d expect to see. When the most significant appetite for risk assets this close to all time highs is in the US large caps – which of course have relatively stable prices and, most significantly, dividends – something is just not right. I’m not even going to go into the reasons why I think this might be. I have theories, but the evidence is right in front of us, and so in a pretty significant way none of that really matters now. With that said, let’s peel back the covers and see what there is to see:

 

spx50r

compq50r

indu50r

One of my favorite at-a-glance ways to gauge the health of any of the indexes is to look at the percentage of stocks above their 50-day MAs against the price of the index. In each of the indexes, in the large caps especially, we see large divergences appearing. This means one thing – weak breadth. The large cap indexes are looking mostly OK on the surface because they are being propped up by just a few names. Compare the recent prices to the percentages and you’ll see what I mean. The SPX at 2081 with the percentage at 44? The last few weeks the index price has been much lower with similar or higher percentage. To me this means we may no longer be at just an inflection point. We may finally see some significant selling take place. A market held up by just a few names is not exactly the picture of health.

A few more items worth highlighting:

VIX

While it’s true the VIX isn’t expecting much volatility, in some ways I think the VIX is a broken indicator. At times when large money is planning to do the selling they won’t be buying protection for long positions. Why would they? It’s insurance they don’t need and it sends up a huge red flare that something is about to happen. Which, of course, is counterproductive for them.

inverseETF

Next, inverse ETF volume spiked in a huge way on Friday. This means one thing – traders of many sizes are looking to position themselves for a drop.

sp500COT

Once again, combined large money positions in both the SPOOs e-mini and big contract remains net short and has been some for some time. The short positions reached a peak a while  ago and my interpretation of this – given the other clues I see – is that the short positions are no longer hedges but now may be (at least in part) directional bets.

oexpc

Finally methinks it’s worth calling out a decades-long extreme in bearish bets on the largest of the US large caps going into this week. The P/C ratio against the S&P 100 is about 2:25 to 1. This is monstrous, relatively speaking, and hasn’t been this high in a decade and a half. If this isn’t a zero-confidence vote, not sure what is.

Anyway, as I’ve said many times before I make a plan for both directions, favor one direction, and determine what criteria I’ll use to execute that plan for one direction. Or the other if I’m wrong. This week it should be pretty clear I’m  looking for some downside. It may come early or late in the week if it comes at all. I’m not saying we’ll wake to a monster gap down on Monday, though that is a possibility.

On the downside the first important area to watch is the area between the Friday low and about 2045. This is an area of extremely weak structure and I expect that to be covered quickly of selling can manage to push through about 2060. Next, we have the extremely obvious area of support (#2 on the chart below) from 2040 to about 2030. If sellers manage to destroy long positions in this region  this region I fully expect a test of the lower value of this zone at around 1985.  If 1985 fails to produce buyers then I have to start looking to the 1950-70 area.

ES1

So there it is folks, a summation of what I’m thinking is possible and plausible in the week (or even weeks) ahead. There are lots of ways in which this could be wrong and maybe we’ll hold or move higher. But my sense is now stronger than it’s been in many moons that we’re about to see a significant intermediate term character change in the equities markets. As I do in times like this, I let it play out and take it one day at a time. But in my experience it pays to always know what the higher time frame is up to, and at this point I think they’re having having a harder time covering their tracks.

West Texas Intermediate

When things look this crazy in equities I may not be making any significant trades in the oil patch. So not covering it this week. But look left on your charts and what’s happening should be pretty obvious.

Trade ’em well this week, amigos…

I Want You to Want… Me

Cowpokes, I think no song better epitomizes the state the US equities market is in as we enter mid April 2015. Here they are, Cheap Trick, live from the Budokan in Tokyo… listen as you read. The opening is the best and pretty much what the SPOOs are saying to you, right now, today, in full-on 70s rock and roll fashion.

S & P 500

Once again, as we have several times in the last few months, we find ourselves at the intersection of Breakout Avenue and Heartbreak Street. We’ve been in the regression channel I’ve posted several times on Twitter recently since December. The SPOOs have tried to breakdown several times and failed. It tried to break out several times and failed also. Now we’ve consolidated our way almost to the bottom of the larger channel,  hit the bottom of the most recent down channel, poked above the top of it on Friday:

ES-Daily

See what I mean? So where do we go now, sweet child o mine? Sorry, couldn’t resist that one.

If I had to guess, based on looking at just this chart, I’d say a test upward is due. I mentioned several times on my daily Twitter homework charts that if buyers could achieve acceptance in the 90s that we’d likely test the ATHs. And I’m sticking to that story.  The chart above shows lots of assertive buying interest in the 30s to 60s the last few weeks. To me, this is clearly OTF activity, and above where we are is where their payday awaits. What’s more, when you zoom out to the weekly, there’s just no denying the massive force of the bull market we’re still clearly in. I mean, look at this thing. It’s a monster:

ES-Weekly

There’s a couple ways that bull trends generally take a larger pause (or end). The first is a “blow off top,” marked by frenzied buying and parabolic candles. In auction theory terms, this is known as excess. Look at the chart above, nothing like that yet. The other way is when, to but it plainly, there’s just no one left to buy. Everyone likes the market (or specific stock), but everyone who wants to own it at a given point in time already does. This kind of thing has happened several times with AAPL over the last few years, for example. A part of me thinks this is kind of the place were in now with US large caps. We’ve had about a dozen attempts in the ES at holding the 2100 zone and each time it failed. Not with a big bloody sell off, but with a push back down to recent value. Each time we bounce up we bounce a little less high, kind of lke a slinky walking down stairs. Look at the daily chart above again and tell me you don’t see what I mean.

So as of Friday we’re in just the right place to test the “Slinky” metaphor, aren’t we? If there’s no one left to buy (for a couple of very practical reasons I won’t bore you with here), then we should see some longs ready to take some profits and the Slinky will start rolling over toward the next step down.

So which is it? Breakup or breakdown? Well, this time it’s complicated. Let me show you a couple things, and you’ll (hopefully) see what I mean. First, not that it’s the be-all-end-all, but SentimenTrader has some pretty good charts which can help with sentiment (duh) and seasonality in particular. So according this this measure, we’re now in extreme territory just like we were a few weeks ago with the so-called “smart money” and “dumb money” viciously at odds over the market direction:

chart (1)

This chart says big players have little interest and are expecting and/or positioning for the market to take a dive while at the same time small players are excessively bullish in outlook. Honestly, I really never pay too much attention to sentiment indicators and measures except when we’re at intermediate term inflection points, like we are now.

The next thing I want to call to your attention, gentle readers, is this week of April 7 Commitment of Trader’s report. Bottom line is that in this report every category of trader which is required to report is net short in the ES now, some by a huge margin, and only one category required to report is net long in the big SPOOs contract. The report is linked there, have a look-see for yourself.

Now if you don’t know already, it’s important to point out that there’s just no way to know why any class of trader is net short or long from the COT. All we know is they are positioned one way or the other on a  net basis. Keep in mind that all futures contracts are both positioning and hedging instruments. So for example, if I run a hedge (or whatever) fund and I have big long equity exposure and I’m not feeling confident about the market’s direction I can hedge off some my market risk by shorting the ES. That way if the market goes down my losses are at least somewhat muted by the gains from my short contracts. The other possible reason to be net short is that you are confident that the market is going down and you want to make a levered directional bet. We don’t know why there’s all this net short exposure now, and that’s the reality. But it’s there for sure.

OK, so let’s get back to the upcoming week. Here’s the thing I am watching like a hawk now. I call it the come-to-Jesus line, and I think it will help us know whether this up-move is for real or just a… wait for it… Cheap Trick:

ES-Range

Basically, I want to see how the ES reacts to this trend top – or whether it fails to get there at all – before I make any big directional bets. Let’s be honest, it’s not like the journey even to the 2090s was smooth and stable, leaving solid structure underneath as a base:

ES-RTH

There are some significant flaws in this move up in my view, and Friday left a pitifully weak and ugly P-shaped (imbalanced selling) profile. So lets see what Monday brings. Speaking of Monday, know that I’m taking this one day at a time now. Given the current location, I think it’s silly to look out any further, so I’m calling the bull/bear zone for Monday around 2091, and watching the 96, 2100, 03 and 05 levels like a hawk to see how we react.

ES2

If sellers are found, we have all kinds of targets from the 90s down to about 2047. Let’s shake this tree and see who falls out, I say. ;-}

West Texas Intermediate Crude

If you’ve been trading this contract the last several weeks then you know this monthly chart is the only one you need to pay attention to for anything other than intraday prices:

www.tradingview

 

Contact with this trend line will either act at a floor for a rally (looking that way at the moment) or if it’s broken it sure seems we’ll head for the depth below with force. Round and round she goes, and where she stops nobody knows…

Trade ’em well this week, amigos…

Dry as a Bone

Not a ton of time to get creative with the weekly check-in/check-up, amigos. Spring’s here and I have many projects grasping for my attention. So you’ll get just the unvarnished, straight dope this week.

And that’s OK as I see things lining up pretty clearly from both a macro and technical perspective. But I also have to say that the last 2 weeks straight I’ve been dead wrong in terms of my favored directional scenario. 2 weeks ago it appeared we were poised for a rout and instead we rallied. Last week the charts looked poised for a challenge of new highs (post FOMC) and instead it was three days of liquidation with a respite on Thursday and Friday.

So what’s it mean? What’s the point then if you can’t predict what will happen next ?

For my trading time frame and style, the process of idea generation is really the critical thing. When I have 2 logical directional plans, being right in the moral (ego) sense becomes irrelevant. Preparing (for me) means defining a hypothesis, establishing the criteria to test it. If it proves itself, fine. If not, well I have another one already in my pocket. Just switch mindsets and go with it.

When you have the freedom of both directions and a plan for each, being wrong is just as valuable as being right.  Creating a plan with a favored scenario gives me a theory to test. I plan 2 scenarios each week, chose the one I favor based on the technical factors I see and then identify what evidence I need in order for that plan to be trade-able. If the evidence doesn’t materialize, that’s critical information. You can lean on what a market doesn’t do as reliably as what it actually accomplishes.

Now that that’s out of the way, where’re we at? Where’re we headed?

S & P 500

Early this week the most pressing business in my view is for the ES to do some repair (or rejection) of the zone from about 2080 down to around 2065, marked on the chart below. This zone was created during Wednesday’s 40 point liquidation. We retreated to a large area of prior acceptance from 2060 down to around last week’s expected range low of 2038. We hung in there for 2 days, with Friday being a balanced inside/inside/inside day – that is inside prior day range, inside prior value and inside the ON range. Almost without fail when the market creates that kind of tight balance, it’s simply waiting for the right time to ease on down (or up) the dusty trail.

So for the week my bull/bear zone (a.k.a. a line in the sand) is from about 2075 down to 2070. The high side of the expected range goes to about 2108 and extends to 2127 and 2144. On the down side I’m looking at 2036 down to 2016 and 1999.
ES

 

We have a a ton of confluence in the bull/bear zone, including the March VWAP, last week’s VWAP, 50% of the weekly range and the midpoint of my intermediate term trend channel. Plus it’s the closest market structure repair zone:

ES2

I’m expecting, barring macro surprises, we will spend at least a little time trying to find acceptance in the region shown above. Even if the bulls manage to find a day or two of acceptance, I’m having a hard time seeing how it can hold. The bigger macro picture shows us that we’re in the midst of the Q1 buyback blackout, and the lack of corporate buybacks drain an important source of support from the large cap market. Of course, all stocks are affected by the blackout, I think large caps are fully valued somewhere in here. Recent economic data’s been decent but not blowout and has not given the market much appetite for multiple expansion (essentially valuation inflation, too much money with no better home causing prices to rise).

For these reasons I’m expecting the bears to take full advantage of any selling presented by overweight funds looking to book some profits and clip some risk. Prices seem especially vulnerable to downside pressure now that Q1 has all but closed and there’s no pressing need to dress up the windows again until the summer.

But as always, we get what we get and I’ll trade the opportunities presented.

The Rude Crude

3rd week in a row I am not covering WTI. There’s been more than enough volatility in the ES and NQ to keep me occupied. Friday was a massively wild ride on the WTI roller coaster, of course. No reason to expect this kind of volatility to suddenly disappear either given the situation in the Middle East (and elsewhere).

Trade ’em well this week, amigos…

 

Dr. Janet Feelgood, I Presume

Last week didn’t really play out like I expected at all. Not that it (the why or my opinion) matters, but ultimately lots of macro things worked out in the markets’ favor. Putin resurfaced, the FOMC effectively pushed federal funds rate changes out on the calendar, Greece didn’t get kicked out of the EU (yet) and middling economic/earnings news was bought fairly furiously. Blah, blah blah.

If I had to sum up the week’s action in a song, this would have to be Dr. Feelgood from Mötley Crüe. Let’s face it – sex, drugs & rock n’ roll are what this market is all about now. Partying like it’s (Nasdaq in) 1999. Hookers and blow for everyone!

S & P 500

Seriously though, this market appears unstoppable. I thought last week there was a good technical case for downside to be made. I know I wasn’t alone in that thesis. But it became pretty clear on Wednesday morning, pre FOMC, that the downside case was just plain wrong. I saw it unfolding and traded accordingly. Since then most of the SPOO short positions were likely crushed. Some SPY and ES option premium sellers probably wish they had hung themselves. There’s a reason why this inspired max pain diagram was first created (source):

 

CAf3E4TVAAAvjLz

 

Anyway, as I looked across the board this weekend at the senior indices, it’s hard to argue it’s not looking constructive for higher:

[one_half first]

SPX

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R2K

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[one_half first]

DOW

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[one_half]

SPMID

 

[/one_half]

[one_half first]

NASD

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[hr_invisible]

That said and shown, way back when I was a kid there was a game they played on Sesame Street called which one of these is not like the other? and the set of charts above is a good candidate for this game too. Cue up the song, give it a play while you look at the charts and I’ll wait.

Done already?

Yep, that’s right. It’s the Nasdaq 100 chart. It had a big gap up which met by some significant afternoon selling pushing it into red territory for the day. This is something to watch for next week. The start of something bigger? Or maybe just profit taking in a couple sectors which have gotten a little frothy (bio-tech names, et al)?

Basically, as I mentioned above in my view we’re in a location in the SPOOs where the weak shorts (and probably all but the strongest ones) have likely been squeezed out. Given this the ES won’t have a free stop ride higher and some initiative buying is needed to push the ES to new highs. The question, of course, is whether this will happen. In the event it does I’m looking at the following target area for the RTH session to complete an intermediate term auction:

 

ES

The 2135 area balances out a remarkably almost balanced composite profile from and 2132 is 127% (a mathematically magic number, 1.27 * 1.27 = the golden ratio) of the range from March 11th to the RTH all time high. When you’re off the map, measured moves of one kind or another all you have to go on. This has proven to be a good yardstick for me in the past so I keep using it.

On the weekly time frame, here’re the ranges I’m looking at:

ES2

My so-called bull/bear area, a.k.a. line in the sand, a.k.a. the zone above which buyers are in control and below which sellers are in control, on the weekly time frame is from around 2082-2075. ETH range targets above include 2118, 2126 and all the way up to 2043. Below I’m looking at 2038 down all the way to the 2-week profile balance target of 2003. 2003 is also a prominent low-volume area on the composite profile shown above. There are many great areas of opportunity in between too, of course.

WTI

For the 3rd consecutive week I’m not covering oil. There’s been more than enough volatility in the indexes to require my full attention. We’ll see if that continues, but with the VIX closing just above 13 on Friday the market’s expecting a lazy trade in the SPOOs.

 Trade ’em well this week amigos…

Going Down Like Disco?

I’ve decided I’m sticking with my cheesy music and movie line/title/pun title theme for a while. It’s entertaining for me. Maybe for you too. TA can be dry stuff. So why not?

This week’s post title is actually a song by the Dandy Warhols, a kooler than cool band from Portland, Oregon who’ve been influencing some of the best indie bands for decades. Have a listen to the song while you read for the full effect. Plus it’s got cowbell which automatically makes it awesome.

 

S & P 500

We had  an interesting week with a nice pickup in volatility, as I was expecting (hoping for) last week. But it was a tough read some days. Friday, many (most?) were expecting a kind of “royal flush” mentioned a few times during the week, but the bulls stepped in, shouted nada! and bid price right back up to the weekly VWAP around 2048. You can never know for sure, but my feeling is that price action this week was warped somewhat by the index futures March-June contract roll, and possibly some jockeying ahead of this coming week’s triple options expiration.

Anyway, I think this one chart sums up the week and also gives us some insight into where we may be headed. Believe it or not, you can read our Evolution charts (or other profile charts, really) a lot like a flow diagram. That’s why the Evolution charts are one of my favorites… they are really great at telling a story day-by-day, week-by-week, etc. Stories put any subject in context, context makes abstract ideas concrete. But I digress…

Start from the upper left, move to the right, follow the arrows:

ES

 

While we’re on the weekly time frame, let’s have a look-see at a couple weekly charts of the SPX.

 

[one_half first]

SPX

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[one_half]

SPX2

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On the left we have a 2 standard deviation regression channel of the recent solid up-trend from mid-November 2012 to now. On the right there’s a closeup of the past few weeks with an ascending triangle drawn. The two things to notice about this very traditional, basic TA chart is that the middle of the channel was rejected 3 weeks ago and we’ve never really looked back since. This is not a pattern the SPX sees very often. In fact, the last couple times it’s made an appearance was in the breakdown of the trend from March of 2009 to 2011 (left) and July of 2002 to January of 2008 (right):

 

[one_half first]

SPX3

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SPX4

[/one_half]

 

Twice this regression line rejection proved to be a precursor to a significant pullback or correction. Before I get all giddy imagining the smell of red candles burning bright tomorrow, notice that on the left chart above, during a similar rejection of the regression line (July of 2010) the index bounced right back into the channel. Which is to say anything can happen and the market is always right. Said another way, we have to prepare for multiple scenarios as traders. Which is a brilliant segue into the week ahead, if I do say so myself. ;-}

First, let’s start with some March seasonality statistics for the S & P 500 and the Nasdaq indexes (via SentimenTrader):

 

seasonal_march_spx

 

seasonal_march_ndx

 

Notice that less than half of the time March 16 is a positive day for both indexes and it’s a crap shoot for St Patrick’s Day. Then following the down days there is a stronger tendency, especially in the Nasdaq, for a bounce. I’ll definitely be watching to see if this is holds true this time. The farther we fall, the more inviting price becomes for buyers, save any macro force majeure. And amigos, I don’t have to tell you there’s plenty of news risk and big economic events on this week’s calendar, any of which (read: FOMC) could create a stir.

I’m actually expecting that we’ll be exploring both sides of the current balance area this week to one degree or another. At this point the HUGE consolidation zone between about 2050 and 1975 has a ton of structure, and save some crazy new events such as the death of Putin and a takeover of the Russian government by extremists or Greece (Spain? Italy?) getting kicked out of the EU, it’s most logical to expect that to be a tough zone to break through. Things just aren’t that bad, honestly, and dip buyers have shown they’re ready, willing and able to buy. So for the week ahead I think the 2040ish composite VPOC is set up as the most logical bull/bear line:

 

ES2

 

Given what I see I think the most likely zones of exploration are from 2040 down to the balance area around 1985 and from 2040 up to the balance area around 2085. Yep, a full 100 point range. Not that we’ll cover it all, but look left on your weekly charts and you’ll see it’s not out of the question. Again, I won’t be shocked at all to see some exploration of both zones, though I’m favoring scenarios in which explore lower first. We’ll see what we get…

The Rude Crude (Oil)

Not covering WTI again this week for the same reasons as last week. Though with a close on the 45 handle, which concluded the week with a huge and solid trend down, there may be a fat pitch to swing at very soon. Charts say lower still from here, with a strong trend in place, but the move is extended enough that it might invite buyers in to trap late sellers for a (short) squeeze play.

Trade ’em well, amigos…

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:

deathorglory

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:

ESTails

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

SPX

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:

ESRange

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:

ESGaps

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…

Keep Your Head on a Swivel

There’s an expression among aviators/pilots which goes keep your head on a swivel. It’s the kind of thing they say to each other as a reminder to stay alert in calmer flight times, just when the first hints that something “interesting” might be about to happen. Here I see my focus markets at important short-term technical spots and set up for some stronger directional force than we’ve had of late.

So here we go…

WTI Crude Oil

Well, looking at last week’s post, I said I felt that buyers really needed to defend the 49,50s, and as it turns out they did a pretty nice job . We closed right on that number and basically the mid/VPOC of the January 12 to Friday profile. This is an interesting time frame as it represents the most recent and significant attempt to find an intermediate term bottom:

 

Intermediate Volume Profile

 

We closed right on 49.52 and in very good balance. As a reminder, profile balances mean that, over a given range of prices and time, the market has found motivated buyers and sellers at low and high prices, respectively, as well as a region “fair” prices in the middle. In a word, the the WTI market has reached an equilibrium,  seen from the point of view above.

Now that we’ve reached an equilibrium and defined a range of fair prices (aka a value area), what’s next? Well, without a doubt this is really an even more critical technical juncture than we were at last week. Previous weeks had buyers were snapping up the contracts left and right. This week, while it’s clear buyers were active and motivated, their thirst seemed to be pretty well slaked at all but the lowest prices available. Just check out the tails hanging off the bottom of the candles on the above daily chart.

That said, the inventory reports show we’re still building stores, generally, and of course producers continue selling into this market every day because they have to. Shale producers can’t really just shut off their currently producing wells by turning a valve, nor would it make economic sense to do so for many of them, so says the EIA analysis. Anyway, this week was a great example of this steady selling pressure. In the chart below both sides asserted themselves at times, but there was a clear down-sloping axis around which the action rotated:

Weekly Trend Axis

So where does that leave us? Well, if we look at some of the other parts of the domestic energy complex such as natural gas and RBOB prices we can see that they are also contemplating bottoms with the RBOB contract starting to go parabolic. Keep in mind that we’re also coming into the North American driving season so, you know, seasonality is a factor there.

Today, Sunday, we’re at a key technical juncture. We closed on at the most accepted price of WTI since mid January. The last swing has been lower. There’s really little room for doubt in my mind that bulls have to keep the buying lust going for higher prices. While it’s true they are seeing value here, it’s also very true that we have way more then enough waxy shale grease to go ’round. Short of some supply disruptions or calculated short-lived short squeezes, I see the most plausible tenor for the week as a gradual drift to test the upper 40s range:

CL2

Significant nearly support areas I am watching include the 48.50s, 47.80s, 46, and the 45.20s. Above we have 50, 51.20s, 52.40s and 54.20s. As with this last week anywhere above 53 is a potential squeeze zone.

 

S & P 500

Meanwhile this week was, at times, excruciatingly slow in the SPOOs. While sellers really didn’t show up in force buyers showed no real motivation to push the index higher. In fact, for a couple of days while the overall index drifted higher there was selling under the covers, as evidenced by the percentage of SPX names above their respective 50DMAs:

sc

Essentially this some selling under the covers index was taking place or some names were correcting with time and may find support. Not exactly uber-bullish picture. We closed essentially right on last week’s SPY option maximum pain number of 210, which also corresponds to a big LVA/bottom of balance area in the ES:

ES

At this point I don’t think there’s a reason to be bearish, from a technical perspective. Be ready for weakness? Sure. But that’s not the same as bearishness in my view. It’s the beginning of a new month which has the potential to bring more selling but also a the potential for an influx of new money to enter the market and push to new highs. Don’t forget the ECB begins their QE program next week.

If buyers fail to buy this dip, they may provide support in the next area of balance below at 2100 down to about 2082. If sellers manage push through there’s a big ‘ol pocket of air between 2082 and about 2068 as well as an open gap at 2066. Large caps would probably be seen as a much better value down there.

Anyway, my view is that it’s all on the buyers now. Failing to support assertively around 2095-2100 means I’ll be watching 2089 for signs continued weakness or merely tepid buying. The air pocket then begs for added attention. Above the 2100 area we have 2107, 2111 and 2117 areas as known resistance.

Even though the market is not expecting much volatility with the VIX closing a little above 13, for some reason I’m optimistic that we’ll see a more exciting week. Assertive bears and bulls, if they show up, aren’t going to telegraph a plan at this stage.

But we’ll get what we get, as always. Trade ’em well this week, amigos…