Archive for the ‘Equities & Indices’ Category

‘Risk-off trade’ Likely Has More Room

November 22, 2010 Leave a comment

Markets, across all asset classes (risk-on, risk-off trade), suffered sharp losses, with modest bounces taking place during the last few days. We are now left with the question – was the downdraft just another “buy-the-dip” opportunity, or could the sell-off be the beginning of a trend change? There are indeed several sentiment measurements published by different folks which point to the possibility that we might be in the process of forming an intermediate top. One of the more notable polls, in equities, the II (Investor’s Intelligence), recently reached up into levels seen at previous peaks, including the one made in 2007. Commodities such as Oil and Gold saw record levels in speculative holdings in their respective futures contracts.

Recently, there were several great short opportunities, especially in the commodity sector where obvious signs of speculative fervor were prevelent. One needs to look no further than silver, sugar, ags and cotton to see this. Now is the time for the ‘risk-on trade’ to prove its worth it’s salt, or fail.

At this juncture, one of a couple of scenarios will likely play out. a.) Markets will settle out and form a basing pattern, allowing market participants to gather their breath for another leg higher. Or, b.) we will see volatility in the form of see-sawing price action, whereby the buyers and sellers duke it out before seeing the bulls succumb to selling pressure. Furthermore, if we are in the process of forming a top, then we should see many of the high correlations between assets demonstrate reversion to the mean; this is not to say they will completely diverge, but rather dance to slightly different beats. The first correlation, or ‘anti-correlation’, which is likely to see the biggest correction to the mean is between the Dollar and equities. During recent months, equity traders have in effect become currency traders, and vice-a-versa. However, it is still very possible that the correlations will break down, whether we are amidst a top or simply digesting recent gains before thrusting higher.

Bottom line; be patient, opportunities of significance will, as they always do, rear their pretty heads. My biggest focus right now lies in the FX/Commodity sectors. The Dollar bullish trade looks like, from where I’m sitting, to be the best opportunity on this small pullback. Last week, I touched on this trade in a bit more detail, click here last weeks commentary. Technically speaking: EURUSD – weak bounce, looking for uptrend line going back to June to get tested in the 1.33 area; AUDUSD – head-and-shoulders pattern forming (should it trigger, .9275-.93 will be the target; GBPUSD – trying to maintain a a trend-line extending back to early September – trust until broken.


Precious metals also look like they will experience another leg lower, as the speculative excesses, particularly in silver, have not likely been purged enough to warrant bullish bets at this time. Gold appears to be forming a head-and-shoulders pattern, which may have a very weak right shoulder should the next push lower begin shortly. Stay tuned for further updates.


Dollar Rallies, Equities Retreat, And Silver Implodes

November 9, 2010 Leave a comment

On Sunday, in "Weekly Preview: Nov. 8-12",  I expressed a strong bias towards establishing Dollar bullish positions while taking a bearish stance on equity indices. Also, in addition to these core ideas, in recent days, I pointed out three individual stock ideas (one bearish & two triangle set-ups without definitive biases, click here and here), and another triangle set-up in USDJPY. So far, the Dollar has rallied smartly off the LT trend-line, equity indices have begun pulling back, the stock ideas are in a holding pattern, and USDJPY — after making a head-fake lower this morning — joined the Dollar rally by breaking out above the top-side trend-line of the triangle.

Today, what really grabbed my attention; the precious metal sector, more specifically – Silver. The volatility seen today has very few precedence.  This afternoon, silver experienced an 11% reversal from high to low in less than three hours. Gold — not having garnered the same degree of speculative fervor — was much tamer with a daily range of only 3%. What ignited the post-market sell-off in Silver was a letter sent out by the CME outlining higher margin requirements; so it seems. However, interestingly enough, upon closer inspection, the S&P, and the 'risk-on trade' in general, was under pressure all afternoon. During much of Silver's (SI) sell-off, the price movement correlation to the S&P 500 ranged between 60-100% on a 5 minute intra-day chart.  The fact is — reactions with so few historical precedence — do not occur on news of this type, which, in my opinion, demonstrates just how grossly overbought Silver is.

Silver es

Back on 10/18, I felt we were upon a decent short-selling opportunity — SI pulled back quietly, touching the 20 day ema — but, today's action created the type of reversal that spawns extended periods of volatility and price weakness. Due to Silver's volatility and wild swings often associated with inflection points, it shouldn't come as a surprise if we see a retest of today's high, 29.34, before rolling over. With that in mind, it would be prudent to consider this possibility when devising a trading plan.


Interest rates are already presenting an interesting 'fade-the-fed' trade. I know this contrarian idea is at odds with the age-old axiom, "Don't fight the fed". However, when 5-year rates  decline from 2.75%, as they were back in April, to last week's low of just above 1%, I am left wondering how much more down-side is left in this move. The 10-year rate could be carving out a bullish inverted head-and-shoulders pattern. I will continue to monitor the situation for any low-risk entry points.

Summing it up: From where I'm perched, at this time, the most explosive opportunities are in the FX markets and precious metals. Specifically, I am focused on Dollar long positions expressed through shorts in the EURUSD, GBPUSD & long USDJPY, AND Short positions most heavily concentrated in Silver, with some Gold. Additional set-ups: Long SPY & QQQQ puts; short LVS. Pending trades: NFLX and BIDU. (Trade Update: EURJPY needs to hold above 111.25 ,at this time, for me to remain constructive.)

Weekly Preview: Nov. 8-12

November 7, 2010 Leave a comment


Heading into last week, despite bubbling optimism for stocks, consensus had grown widespread amongst market participants, even in the bull camp, that profit taking would set in once the FOMC outlined their intentions for QE2 (sell-the-news). Indeed, thus far, this has not been the case. Financial stocks have benefited the most, shooting up over 5.5% during the two days following the meeting. The size of the LSAP program was within market expectations, however, the average maturity of the new purchases was not. The average maturity will be between five and six years; thus putting the curve steepening trade back in play, helping boost bank's profitability.

At some point this week I expect weakness to develop in the 'risk trade'.  I am by no means calling for THE top to take place, but risk appears to be strongly favoring a pullback. On two prior occasions during the month of October I anticipated a pullback in equities, but to no avail. This time, however, the market is demonstrating signs of "blowing-off" with the most recent surge appearing to be coming from capitulating bears and panicky bulls. The S&P may hold below the top-side of the multi-week rising channel, providing a backstop for bearish bets. Once markets pullback, we can access the damage and get a better idea as to whether the pullback is the beginning of a larger reversal or simply a healthy correction.



Commodities have been the hottest game in town. Both industrial and precious metals have been racking up huge gains while agricultural sectors have been acting simply outrageous. Cotton and Sugar have been leading the speculative frenzy with price charts bending back to the left – registering multi-month percentage gains in the triple digits. For those with the intestinal fortitude, a high yielding short set-up is in the making.

In the months to follow, it will be interesting to see how much of an impact the rising cost of raw materials will have on profit margins. To what extent will businesses be able to pass through rising cost to a consumer stuck in a balance sheet recession? This will be, to say the least, an important development to pay to attention to. If the economy can take the torch from the Fed and grow on its own, then this may turn out to be a non-issue, however; if the economy continues to muddle along then an unintended consequence of QE2, squeeze on profit margins, could rear its ugly head. As they say – only time will tell.


On Friday the Dollar Index (DXY) bounced off a long-term trend-line. My bias since mid-October, based on historically extreme pessimism, has been that the downtrend in the Dollar is closing in on a reversal, however, price action — the final arbiter — has yet to cooperate. From a pure risk/reward viewpoint, establishing a long position off the long-term trend-line makes a lot of sense; regardless of the outcome. Presently, I am leaning towards short positions in EURUSD, GBPUSD, and long positions in USDCHF, and possibly USDJPY. I will follow up with more details surrounding these pairs as the action unfolds.


Interest Rates:

I don't see a particularly strong edge in making any moves against the short to intermediate term maturities, however, a rally in rates would be consistent with the before mentioned biases. The 30-year could become an interesting trade in light of the fact that the Fed isn't going to be focusing their purchases on the long end of the curve. A bearish topping pattern is in the cards for the 30-yr futures (US) which will further support this idea.

Bottom Line:

Dollar bullish trades look to hold very favorable risk/reward opportunities as long as the long-term trend line holds. In addition, purchasing puts in Index ETF's, considering how inexpensive volatility is, looks like a solid risk/reward play off the upper band of the rising channel. Also, on the radar are a pair of short set-ups in individual equity names –NFLX, LVS — click here for the NFLX trade outlined late last week, and check out the chart below for details regarding LVS.





Stocks Overbought, November 3rd Is Looming

October 25, 2010 Leave a comment

Last week, I went over a few indicators pointing to a pullback in equities from a sentiment standpoint, but as I mentioned – an extreme in sentiment isn't in of itself a reason to buy or sell. A fundamental catalyst and/or the technical picture needs to confirm conclusions drawn from sentiment data. We may get both within the next two weeks.

This morning, the S&P 500 touched the 200 week SMA for the first time since June of 2008, however, it came close back in April – that turned out to be the sweet spot for sellers. The current set-up doesn't create a bearish case as compelling as the one in April, but when taking the 200 week into consideration with the level of bullishness and long-term technical support in the equity market's inverse ETF, the U.S. Dollar, it becomes quite evident that the risk for long positions is growing with each passing day. Also, the menacing posture of financial stocks, as evidenced by the SPDR ETF – XLF, provides further reason for concern.

      SPX touches 200 week SMA              Dollar Index (DXY) LT T-Line, Pessimism

Spx weekly          DOLLAR INDEX

On November 3rd, expectation, as everyone knows, is that the Fed could announce plans for more QE, and as such stocks look like they want to continue churning until then. This is beginning to look more and more like a classic buy the rumor, sell the news trade.

However, there does exist a bearish set-up, which if triggered could bring weakness to markets in the days to come. I am referring to a rising wedge on the 60 minute/multi-day chart, which sans the before mentioned FOMC meeting, I would feel more confident about.  But, since the market has been "geeked up" for several weeks now in anticipation of a move by the Fed, I am viewing this set-up with a cautious eye. The market is very close to triggering the underside trend-line of the wedge, and if it does the near term target is 1155-1160.

ES Futures – Multi-day Rising Wedge

Es rising wedge

Sentiment In Equity Markets Flashing Signs Of Caution

October 21, 2010 Leave a comment

Earlier in the week, I highlighted the bullish extremes present across a wide spectrum of asset classes, and expressed my bearish tilt on certain FX pairs and precious metals. However, I only briefly touched on equities, and so it seems prudent given the current sentiment levels that I delve more into the situation brewing in equities.

Before getting started, I want to point out that simply identifying extremes in sentiment, in of itself, does not warrant a trade, at least not by the rules from which I operate. Sentiment indicators are powerful tools for identifying  price points where reversals are more likely to occur due to herding behavior. It provides the initial edge, but what sets the trade in motion is price action, by providing confirmation of trend saturation and reference points for assessing risk.

Sentiment Indicators In Focus:

AAII (American Association of Individual Investors) – Mom & Pop investors have been warming up to stocks quite a bit lately, in fact, so much so that the 4-week average of the AAII has extended towards the highest levels seen in half a decade.

Source: Sentimentrader

II (Investor's Intelligence – (or lack of))- Newsletter writers are also showing some love for equities, not to the degree as individual investors, but none the less they are still climbing aboard. This week the II Bull Ratio rose to an overbought reading of 67.1%, but still well shy of the 75%+ readings seen back in April and January.

Composite Model by Sentimentrader This model is a compilation of various indicators including sentiment surveys, Commitments of Traders data, put/call and open interest ratios, volatility indices, breadth ratios, TRIN, and several unpublished indicators, which Jason at Sentiment has under lock and key. As one can imagine, with all those inputs, it gives a pretty well rounded view of what is going on under the market's hood.

On 10/14 the reading for the Composite Model dropped to 23%, which is only the 11th time since the data began in 2000 that a reading fell below 25%. As you can see from the table below, when the indicator fell below 25% the market had a tendency to struggle in the next 2-4 weeks, and in a few instances much longer.

For this study, I outlined the number of days it took to reach a peak, which I defined as a price high proceeding a decline resulting in a close one month later that is lower than the peak price. The peak dates were also determined by looking at the first day the model pivoted higher after crossing below 25, which is consistent with mybelief that contrarian trades shouldn't be taken until there is a pause or shift in momentum. Furthermore, I also calculated the return of the market over a two week and one month period. 

If you throw out the three occurrences which occurred at the very beginning of the 2003-2007 cyclical bull market, the market folded in the near term 6 out of 7 times by an average of 3.4% vs. the one time the market rose by 2.1%. The reason I am discounting the 2003 occurrences is due to the extreme nature of sentiment and price at that time, similar to what the markets experienced in the spring of 2009. (Surprisingly, the monster recovery in early 2009 did not push this model below 25%.)

Also, take notice in regards to the amount of time it took for a price decline to materialize. In two instances the peak was 2-3 days prior to the turning point in the Composite model, and in 4 other instances the peak was seen inside of 9 days. This means that if the current extremes are indeed creating an inflection point, then the market should begin to experience weakness very soon.  (The turn date was Monday October 18th.)

  Composite Stats
source: Sentimentrader

U.S. Dollar Sentiment – The inverse correlation between the Dollar and Equities has been a considerable focal point for both technical and fundamental traders alike. The prospects of more QE has created a "what's good for risk assets is bad for the Dollar" mantra, and everyone is buying into it. The Daily Sentiment Index, as seen below, has recently registered pessimistic readings indicating that only 3% of traders are bullish, which is below levels seen in August just before a 4%+ rally ensued, and worse than the levels seen at the 2009 trough.

US dollar DSI sentiment Oct 2010
source: Elliot Wave International

The inverse correlation between the two assets has been extraordinarily strong, and like most correlations it will eventually experience a reversion, that time could be now. With that said, a reversal in the Dollar doesn't necessarily mean equities will also reverse, however; it does suggest some caution is warranted until the Dollar begins to make adjustments to correct the high level of pessimism.

Quick Glance At The Technicals:

Chart #1 – ES contract carving out a possible Reverse Symmetrical Triangle (RST), or a megaphone, depending on who you are talking to.

Chart #2 – EURUSD looks to be rolling over and forming the right shoulder of a H&S pattern.

                      Es megaphone
   Eurusd 240

In conclusion, equities, like other risk assets, look poised to retrace in the near term. I am not as keen on being short equities as I am on remaining bearish on Precious metals and certain FX pairs. On another note, the EURGBP triggered stops at 0.8830 – that's trading, moving on.