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The surge in fear measured by the CBOE implied volatility index -VIX- reached an extreme not seen since 2007, 2008, and 2011. All such price based events were followed by more decline within weeks. The inference is here that a sell-off undercutting the most recent low on the 23rd is an alternative, a bear trap test.  Or, the sell-off should be a full edged downtrend that targets 16,000 – 17,000 on the Dow before a meaningful rally into late Summer early Fall.

The breakdown by the monthly bar beyond three standard deviations from the average is the first time that has occurred since January 2008, a long term bearish signal.  Further on the long term bearish side is the lack of divergence in our OB-OS model on the monthly bar. Add to that, and they are both now just touching the extreme thresholds but were broken back in February 2018; in other words, the market did not reach a L-T oversold yet.

The weekly chart on the right-hand side shows a deep oversold without a buy signal and the market bouncing off the L-T support zone, which is a crucial level now.  If the market falls back into that zone, it would be viewed as a failure to hold its reversal and be dealt with harshly by traders.

The other problem the market has is reflected in the next chart, which is simply lack of liquidity, finding people to trade in general, and finding people to buy dips. I read last night that Market Makers are using a 7% spread in the bid-offer to cover their risk. When significant capital pulls their bids in the face of a sell-off because their policy does not allow hedging or they have maxed out the level of cash allowed, it hurts the market long term. Because short-sellers have to buy back sooner or later, and there is your liquidity. Yet some idiots in Congress want to make it against the law, but then I digress.

The daily bars of the primary indices are all on new TE#2, a call for a trend a call for breakouts getting follow-through, an increase in the rate of change. This is based on the NYSE day session, not the Globex charts. As I go to press here, the offshore traders – and possibly the boys at the USA treasury working with their banker friends – are bidding up the thin overnight markets, which only have 20% of the volume compared to the NYSE. Much easier to front-run, the pre-open is called up 700 Dow points.

One personality trait that most super bulls or bears have is that is is always happening how, and nine times out of ten it is now. They are where your and mine volatility modeling comes into play. Contrary, Thinker does not see a precise five down formation calling this leg of the bear over and in line with the 1929 overlays that so many are using.

Instead, what we might have witnessed from the February 12 peak through the March 23rd low was a crash like 1987 – a massive correction in an ongoing bull market. But it is out view the decline has one more decline with target at 16,000 to 17,000 on the dow to complete and confirm a bear market before we get a meaningful rally. We support the latter view based on our Market Map and the lack of capitulation by the bulls. Instead, what I am reading is everything from jokes to sarcasm to denial about the decline. The easy come easy go attitude is not the stuff bear market bottoms are made of.

However, bears should be on notice that this advisory is not a Perma bear, we are big swing traders and long asset allocators.

The Volatility of Volatility is Mixed

The next two screenshots are of ETFs composed of various term volatility futures. VIXY is a portfolio of the shortest term vehicles, and VXZ is medium or Intermediate-term (I-T) complied with prospects going out five months.  What is clear both broke out on a panic event measured by TEM and was the signals used to go long, only the nearby VX futures with our scalping program. A real winner, up at least 55%.

Since 3/31/2020, when I suggested re-engaging the system, there have been no trades. So today we have a different set of facts in front of us. The Short-Term ETF has failed to hold long term resistance. Not the right size unless the market can get back above 41.08.  The TEM provides a background that suggests a high to low range expansion without indicating direction.  The daily chart of the VIXY reveals it is mid-range the S-T fixed R&S zones. A break above the upper side of the support zone would signal to keep the long-only VX hedge on.  A move below the outside of the S-T support zone would signal status off.

As you can see, the daily chart of VIXY is on a new TE#2, hence the underlying stock market is on the verge of an S-T trending move, one way of the other. The medium-term ETF daily bar can be used in the same way. It shows the 90-minute bar zones and the daily bar, which the later is on a new TE#4 for a range expansion that should rival 5 1/2 to 6 points, either up or down.  Our bias based on the above radical momentum surge in the fear index calling for more decline is bearish; however, it may take a few more days to work off the memory of the decline in the minds of the L-T bulls.

The next chart is the futures themselves, which tells a similar story with two exceptions. The daily bar is also on a new TE#4, calling for a range to challenge the old range high of 24 points.

What is more supportive here for long-only VS futures is the buy signal given by our OB-OS model being out of gear, the vertical magenta line highlights this. It is known to be smack on the date for the reversal. Also, the chart of Nation’s volatility index shows its drifting lower downtrend to have caused a new TE#3, calling it old and feeble and due for a change.

As you can see in the left-hand window, the system has not had a trade since Volatility Reports went back status on March 31.

The VIX.X index is in S-T support, an excellent place to be for traders because it gives two precise levels to signal off of, a break above or below should get carry over. However, this is where TEM is vital because it is calling the downtrend old, low energy, feeble but persistent.  TE#3 may not be too supportive of a breakdown.

The bottom line is Contrary Thinker may go all-in with the edges today if the rally makes new intraday highs and failed to hold, else hedges will be put back on status off until the next COT.

Great and Many Thanks,

Jack F. Cahn, CMT
A Thinking Man’s Trader Since 1989,
Copyright 1989-2018

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