J.W. Jones: The recent action taken by the Federal Reserve Bank as well as other central banks around the world has produced a strong move to the upside in European and U.S. equity markets. Regardless of your stance on the intervention that we have seen recently and in the past, as traders we have to trade the market we have, not the market we want.
I am not one to make bold predictions, but the entire world is bearish right now. At the retail level outflows coming out of equity based mutual funds are on the rise as retail investors have had enough of the whipsaw volatility.
In contrast, day traders love volatility and wild price swings as it offers strong profitability opportunities. The recent price swings in the marketplace have been severe and it is hard to believe that in 2011 the S&P 500 has essentially produced nothing in terms of tangible gains at this point in time.
However, amid the volatile price swings members of my service have been able to sidestep most of the volatile price swings that have the capability of wiping traders out. I focus most of my trades on utilizing the passage of time as a profit engine. Throughout the year I have been able to take consistent profits out of the market for members of my service not because I am the best trader around, but because I recognize risk and I am not scared to sit in cash.
We have sat on the sidelines during this entire move higher. As early as Friday of last week I warned members that a large move was coming and I did not have an edge. I reduced my directional risk and maintained positions that utilized time decay as a tool to either mitigate losses or as the entire profitability engine.
The strategies that I have been using paired with being in cash have paid off immensely. Thursday we were able to close a UUP Call Ratio Spread for a gain of 19% on maximum risk and today we are looking at closing a December USO Call Butterfly Spread which is currently showing gains north of 20% on maximum risk. The other important aspect of sidestepping risk is the protection of emotional capital which is just as important for many traders as the trades they accept.
Similarly to how I felt at the end of the Thanksgiving holiday week, I believe we may be nearing a major turning point in the price action in coming days. The recent move has been extreme and characterized by huge intraday moves. We have moved higher by more than 7% since last Friday’s close. At some point, some form of profit taking or a retracement of this move is likely.
The S&P 500 and most risk assets have rallied sharply as a function of extreme oversold conditions and the expectation that central banks will not allow the European disaster to unfold. However, price has worked into a major resistance zone around the 1,250 – 1,257 price levels. The S&P 500 opened 2011 near the 1,257 price level thus it serves as the Maginot Line for professional money managers. The 1,250 level corresponds with the March 2011 pivot lows.
The daily chart of the S&P 500 Index below illustrates the various resistance levels directly overhead for the S&P 500:
In addition to the 1,250 and 1,257 resistance levels the recent wedge also provides another layer of resistance. The massive overhead resistance is going to be a tough task for the market to push through, but it is entirely possible.
However, I believe we are nearing a top in coming days. Part of my reasoning is based on the sheer size of this move higher in risk assets. It is important to note that I am not sure whether this is just a short term top before price action works above the overhead resistance or if this is a major top that could send prices back down to test the recent lows. Evidence does suggest that we are getting overbought in the short to intermediate term as is evident from the chart below:
The chart above illustrates the amount of stocks trading above their 50 period moving averages. I look at this chart regularly as a guide to the short term overbought/oversold nature of the market. It is pretty clear from this chart that we are reaching overbought levels not seen for quite some time.
Another key element supportive of a possible near term top is the price action in the Volatility Index. Today (Friday) for the first time since July the VIX has tested its 200 period moving average. The daily chart of the VIX is shown below:
If the S&P 500 can push through the various levels of resistance overhead we could see a push toward the 1,300 – 1,330 level in short order. Right now it is too early to say. We need to see the price action over the next few weeks before coming to any significant conclusions. I want readers to recognize that we are at a key inflection point and the next few trading sessions are going to be critical going into year end.
It is important to note that seasonality favors the bulls as professional money managers will be chasing their performance bogeys into year end. I would not be shocked to see prices push higher, but in the near term a sharp retracement or pullback is likely. The question is whether Big Bad Ben can keep Europe afloat, or if their upcoming meeting will shed light on the truth. Anything could happen here and directional risk in either direction is high. Be sure to keep some powder drive and define key risk levels.
Related ETFs: SPDR S&P 500 ETF (NYSEARCA:SPY), ProShares UltraShort S&P500 ETF (NYSEARCA:SDS), ProShares Ultra S&P500 ETF (NYSEARCA:SSO), ProShares Short S&P500 (NYSEARCA:SH), ProShares UltraPro Short S&P500 ETF (NYSEARCA:SPXU).
J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized.