111 on the DIAmonds...

...is the last level of meaningful support (38.2 fibo drawn from the 10/10/02 low to the 10/11/07 high) - after which we have some minor support at 107 and 105 before hitting the 50% retracement level of 102. I'm anticipating some froth at the 111 level but in the end I believe a dead cat bounce will provide just the energy needed to crack this support level.

Also the declining volume on the subsequent big down days tells me that we have not yet reached the bottom. I'm looking for a big volume event on a substantial distribution day to mark the end of the downtrend - capitulation - but we ain't there yet.

I sold my DIA puts for a tidy profit in anticipation of a short bear market rally (or in the event that the 111 support holds), and have lightened up on my other broad market index ETFs. One exception - GLD - I bought puts today as GLD was banging its head on 93. The range between 85 and 93 has been pretty solid and I continue to trade this range with options.

Capitulation? I think not...

As defined by Investopedia, "capitulation" is associated with giving up any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. It usually involves high volume and sharp declines (also known as "panic selling"). Are we there yet? When I look at the price action of the broad market ETFs (DIA, SPY, QQQQ) and listen closely to what the VIX and VXN are whispering, I'm not convinced. Certainly the sharp decline is evident, however, I'm NOT seeing the volume I would expect from panic selling and short interest continues to climb.

A closer look at the VIX...



...shows a repeating pattern - a pause at the current level before the VIX moves significantly and sharply higher. These past VIX moves correspond to "dead cat bounces" in the DIA, SPY, and QQQQ before heading to much lower levels. 117 looks like a certainty on the DIA, the SPY could go all the way to 125, and the QQQQ will test 46 before moving into the lower 40s.

I continue to hold my PUTs on DIA. SPY, and QQQQ with some calendar spreads to hedge. GLD is very frothy but is trading in a range so I'm moving in and out of the newly available options pretty regularly and clipping a few bucks each time. I'm out of GLD as of today with a nice profit on the gap down. A move to 85 would make me think about getting long for a short term bounce back up to the descending trend line.

The Diamonds

In my previous post I made a clear distinction of the relationship between the VIX and the broad market indexes. I consistently trade the DIA (a.k.a. "the Diamonds"), SPY ("the Spiders"), QQQQ ("the Cubes"), and IWM ("the Rut") - I consider them to be the cornerstone of my trading strategy. I am almost always hedged in these instruments and rely on them for steady growth and income. I am also inclined to speculate on individual stocks (usually using options) and partake of some of the "ultra short" products that are around (SDS and SKF are favorites).

Anyway...back to the VIX. The VIX is an index that measures fear and complacency in the market. Basically it is calculated by measuring options activity and plotting it over time. When the VIX is low then there is lots of complacency and everyone is feeling pretty good - the price of stocks fluctuates in a narrow or "normal" range. When the VIX is high there is a lot of fear and so the price of stocks fluctuates widely.

The VIX is a "contrarian" indicator, meaning that it should be interpreted as being inverse to the market. The old saying goes: "If the VIX is low its time to go and if the VIX is high its time to buy". Bearing that in mind, if you look at my previous post and the associated chart you will see that I pointed out the relative "lowness" of the VIX and correlated it to the SPX and DOW. Clearly on May 19th the VIX was saying "time to go". At that time the DOW, S&P, and NASDAQ indices all rolled over and started heading lower. I was mostly in cash so I quickly bought PUTs on the DIA, SPY, and QQQQ. I also went long the SDS and wrote some CALLs against that position. My hedges have been some short term trades of the indexes on the bounces and a couple of stocks (like AAPL) to catch the upside when it occurred. So....I can say that when the VIX whispered in my ear a couple of weeks ago, I'm awfully glad I listened!

Where to now? Good question! My bet is on a continued downward movement of the broad market, although I've substantially lightened up on unhedged PUTs in favor of some complex option spreads. (My trading mantra is "defined risk, positive time decay".) Today's price action and VIX behavior makes the near future look like party time for the bears...but I'm not immune to fear - as the VIX rises so does my concern. This is not a time to be greedy...this is a time to be smart.

Talk to me VIX

Having survived the dogfight of expiration Friday somewhat intact, I find myself leaving the scene in a kind of bleary-eyed, preoccupied stupor - heading away at Mach 1, yet knowing in the back of my mind that I should re-engage. I reach deep into my soul and call out desperately for my long lost flying partner for help..."Talk to me VIX". In an instant I'm pulled back into the fray - re-energized, refreshed, and ready for battle. My old flying partner has revealed some much needed insight. I have managed to keep enough powder dry to finish what was started - victory will be mine. Now if I can just find that darn aircraft carrier...

The VIX is speaking volumes about the current market conditions - coupled with the DOW and SPX banging their heads on some very formidable overhead resistance, it seems like the end of the bear rally might be upon us. The VIX is showing the same level of complacency we saw back in October just as the market hit its highs and rolled over big time. The SPX has shown some strength in climbing back from the lows of 1275 but it has not been an easy climb. When it broke through 1385, the talking heads were quick to proclaim the bottom had been put in and we were turning to the upside, but follow through has been weak on mediocre volume. The cash is still on the sidelines. The DOW is no different - also banging up against the 200 MA and showing even greater weakness than the SPX. The DOW just can't seem to break through 13,000.

So...what am I doing? I'm mostly in cash but have some speculative PUTs on DIA and am long SDS. Up until today I was holding onto GLD for a hedge but decided to take my profits due to the weakening of the metal commodities. Also long some DUG - a small speculative position that is looking for a decline in Oil prices. I'm excited about the market opportunities that are in front of me. I'm looking for the VIX to start to move up and confirm a rollover in the broad market. Just gotta keep a clear head and listen to my gut.

"Requesting permission to buzz the tower".

The AAPL of my eye

Coming off the recent GOOG debacle in conjunction with yesterday's selling pressure on AAPL I couldn`t help but take a long position before yesterday's close - so I got in at 160.80. My thinking was that everyone will be looking at AAPL today but thinking GOOG and that will give me a nice pop in the morning, but I should be thinking to close out at 10-10:15 - before sanity breaks out. Granted a more gutsy move would have been to stay in it till late in the day (but I have a rule about knowing my exit before I enter), but I closed out a little after 10 at 164.40. Good trade - I'm happy. Now...I'm absorbing the AAPL earnings and guidance and am thinking about that lovely gap down below that was created a couple of days ago. Its 3 points from the 50% fibo at 159.20 to the bottom of the gap at 156. We've got some market movers reporting before the bell - I like my chances of filling that gap and will be looking for a short entry first thing in the morning.

SPY - take 2

The SPY didn't confirm the breakout above the inverted H & S neckline so I left it alone, however, the weakness got me thinking about the SDS (Ultrashort S & P 500 ETF) and SKF (Ultrashort Financials). Neither made very big moves, but they were fairly predictable and provided some nice day trade profits. Tomorrow is another day for the SPY - with AAPL reporting after the close you may have to wait another day for the big SPY bull move but I can be patient. Just keep watching that neckline for a strong break above. The bottoming tails on the last 2 daily candles tells a story of bulls that are chomping at the bit. Lastly, take a look at the AD study on the following chart - the institutions are accumulating.

SPY - what's the story?

I'm looking long and hard at the SPY after it closed today and I'm of the opinion that we are seeing an inverted head and shoulders pattern confirming with a neckline at about 138.50. MACD, STO and RSI show bullish strength - and the OBV is started to climb out of the doldrums. Combined with the general herd mentality that *wants* to take the market higher, I think we have the potential for a pretty significant upside move. We have some formidable overhead resistance - the 78.6 (140.26) & 61.8 (143.61) fibos, a downtrend line, and a 200 MA - so things could go either way, but we are at a short term pivot point (138.55). As of this writing, the futures are down a bit, indicating that we might test the bull's resolve in the morning. Today's light volume only validates the basic indecision of the market but tomorrow's earnings announcements should remedy that (AT&T, Coach, Dupont, McDonalds, etc). If the open is strong and holds until 10:00, I'm buying.