BigTrends

Trading Range Bounce - Weekly Market Outlook

Just when it looks like the bears are going to drive the final nail in the coffin, the bulls pick themselves up off the mat and come out fighting again. Friday's huge upside reversal forces us to acknowledge the possibility that we may yet stave off a re-entry into a bear market.

We've got the details below; but first, let's start with the bigger economic picture.

Economic Calendar

It may have been a light week in terms of the amount of economic data, but it was plenty important... particularly on the housing front. And, the news wasn't good. Existing home sales plunged to a multi-year low of 3.83 million, while new home sales plunged to an all-time low annual rate of 276K.

Durable goods orders figures didn't help in the least. July's durable goods orders were up 0.3%, versus expectations of a 3.0% increase. And, when taking out vehicles, durable goods orders actually plunged by 3.8% last month, versus forecasts for a 0.5% improvement.

Oh, and the Q2 GDP figure is going to be closer to 1.6% when the final figure is calculated. It's better than the alternative, but nothing to shout about.

The only bright spot from last week was still a dubious one... unemployment claims dropped. New claims fell from 504K to 473K, which is still higher than the recent average. Ongoing claims fell from 4518K to 4456K, which is in line with the recent levels. No real progress is being seen on either front.

Economic Calendar


As for the coming week, it's going to be a busy one to be sure - too much on the plate to detail, and too much on the plate to try and figure one out before the next one is unveiled. Just keep the calendar above handy, and know that even neutral numbers have been interpreted as bearish lately.

NASDAQ Composite

Don't be shocked that the NASDAQ posted such strong numbers on Friday, gaining 34.94 points to close out at 2153.63. Though still in the hole for the week, the bulk of last week's damage was confined to one day..... Tuesday. Moreover, when you take a step back and look at the bigger picture, the bullishness from Wednesday and Friday starts to look like more than luck.

To be specific, the composite seems to be finding support at two former proven support lines - the horizontal floor (black, dashed) at 2100, and the lower Bollinger band (gray) at 2091.

In fact, when taking the bigger-picture look, it becomes pretty clear the NASDAQ is simply range-bound, as it has been since May, between the two dashed lines. Last week's bullishness is just an attempt to push off the lower edge of the range. And, odds are that it will be able to make good on the effort, especially considering the strong volume buy-in and strong reversal bar we saw on Friday.

As you may have been able to guess from the chart, no bullishness will mean much unless the composite can get past the whole mess of moving averages as well as the upper Bollinger band, which will be around 2300 by the time it can be retested. The upper edge of the trading range is at 2311, which we'll use as the last bullish straw.

COMP Daily Chart


As far as what could trip the bullish effort up at this point (aside from potential resistance at all those moving averages), the biggest threat is

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The Stealth Greek of Option Trading: Vega

In the real world of option trading, option prices are the subjects of three primal forces: price of the underlying, time to expiration, and implied volatility.  Delta and theta address the first of these two primal forces. The third primal force, implied volatility, is by far the least known by newcomers to the option trading world. However, while it is usually not respected or even known by many new to trading options, it typically is the most frequently unrecognized force resulting in is the cause for significant trading capital deterioration.

In order to set the framework within which to understand option pricing, it is essential to understand that the quoted price of each option is in reality the sum of the intrinsic value (if any) and the extrinsic (time) value.  The intrinsic value has been discussed previously and consists of the portion of the premium that reflects the extent to which the particular option is "in the money."

Understanding of the various concepts of volatility is essential to grasping one of the essential defining operational characteristics of the world of options.  Volatility can be considered in light of:

1. What was (SV, statistical volatility; HV historical volatility; & other synonyms of the same)
2. What is,
3. What shall be (IV, implied volatility, and Market Implied Volatility (MIV)

They are all confusingly disparate words and acronyms signifying identical concepts).  Of these three time frames within which volatility can be considered, implied volatility is by far the most important. The nexus point is right here, right now, while the future is unclear and will always be that way. For an option trader to sustain profitability over long periods of time, it is essential to understand implied volatility and its various implications.

Let us consider for a moment the variables defining an option's price.  Intrinsic value is a crisply defined value that requires simply the calculation of the relationship of the price of the underlying to the strike price of the option and can theoretically vary from 0 to infinity. The time value (also termed the extrinsic value) of the option is dependent, in large part, on two distinct variables. These variables are the amount of time to expiration and implied volatility. Time to expiration is easily defined by anyone with access to a calendar and schedule of option expiration dates. Option expiration is easily accessible for option traders, and as such represents a totally transparent variable. Conversely, implied volatility is not as easy to explain, or quantify.

The subjective concept expressed by implied volatility is to be distinguished from the mathematically objective and precise concept of historic volatility.  Historical volatility is simply derived from the price action of the underlying and can be calculated in one or more of several iterations. Each calculation is fundamentally derived from historically apparent price action. 

Implied volatility is not only arduous to understand, it is even more difficult to quantify. A totally different calculation is required; the computation is reflective of a unique and characteristic point of view with regard to price action. It is technically calculated by an iterative process requiring multiple trial and error calculations; thankfully the robust computational ability of the current generation of computers handles this task easily.  Of the three primal forces impacting option price, implied volatility is the only factor subject to cerebration. As an adaptable and subjective input factor, implied volatility is reflective of both general market sentiment and the subjective evaluation of potential future volatility while simultaneously corresponding with the specific direction of the underlying. As such, it is a forward-looking evaluation as opposed to historic volatility which is well, historic.

Implied volatility has a historic and characteristic range for each underlying.  A strong historic tendency is the characteristic for implied volatility to revert to the mean for the particular underlying under consideration.  This strong mean reverting tendency forms one of the primary fundamental tenets of option trading and represents a major opportunity for potential profit in option trading.
The chart below illustrates the behavior of Vega at various strike prices that are expiring in 3 months, 6 months and 9 months when the stock is currently trading at $50.



In addition to the historic backdrop

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Elliott Wave Rally for Gold?

Gold Bullion Likely To Pull Back Then Rocket Higher

Back in June we saw a drop in Gold coming, mostly due to the 5 wave structures up from the October 2008 lows to June highs, and the 5 waves up from February lows to June highs converging.  We then dropped from $1243 at the time of the forecast to $1155, which was one of my potential "A wave down" rally pivots.  I expected a counter-trend rally or "B" wave up to 1212-1225.  So, all of that worked out pretty well, until we hit $1238.  Now, $1238 is a 78% Fibonacci re-tracement of the drop from $1265 to $1155.  Normally, a re-tracement in a weaker market or sector is capped at 61.8% or 50%.

The strength of that counter-trend move caused me to go back and review my patterns a few more times.  Most of this is pure instinct and experience, but I think $1155 was the low of the correction.  It also looks like that was an A B C correction to $1155, and with the strong rally... it means we are likely beginning a new set of 5 waves up from $1155.
We closed our Gold trading short position out several days ago with a small profit.  It is a good thing we did because Gold rallied hard from 1212 to 1243 since that time, catching some people off guard.  At this time, Gold is quite overbought and due for a small corrective pattern. It would seem logical that after a rally from $1155 to $1243 roughly, that we would pull back 38-50% of that move, so I'm looking for a pullback to around $1200 plus, and then a rally.  We could see new highs in Gold in the next few months, and $1300 is on the radar now.

Below is an updated Elliott Wave based chart showing clear corrective (3 wave) patterns from December 2009, and bullish (5 wave) pattern from February through the June 2010 highs.  We just completed a 3-wave correction to $1155, and now this is probably a short-term peak wave 1 up, with a mini-wave 2 down to $1200 or so to follow.  Once done with a pullback, we could see a run to $1280 or so, and later over $1,300.



In summary,

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Bear Acceleration Confirms New Trade Signal [SPY]

August will be the third month of losses for the stock market out of the last four when the books close next Tuesday and we move into September. The major US indices have lost more than 5% across the board with the Dow down just 4.25% and the Russell 2K down 10%. The bearish price action looks like it will continue for the majority of September.

As of Wednesday’s close a new, confirmed bear signal has emerged on the markets and it’s historically dependable.  In addition to the slew warning signs from Monday’s Equity Put/Call, the VIX crossing above its 200 day moving average and poor home sales we are seeing a short signal based on Acceleration Bands. Let me explain what this means…

Perhaps one of the most difficult momentum indicators to trigger a buy or sell for the SP500 is Acceleration Bands - the bands target the top/bottom 5% of bull and bear trends helping traders focus on only strongest moves.  Check out our free Indicator How to Video on Acceleration Bands.  The signals are easy - a traditional Acceleration Band Buy Signal occurs after 2 consecutive closes outside the upper band while a Sell Signal occurs after 2 consecutive closes below the lower bands...

Why is this Important NOW?

Wednesday's close marks the second consecutive close below the lower Acceleration Band meaning a Bearish Acceleration is expected in the market. The previous signals based on acceleration were profitable more often than not.

What’s Bottom line for TRADRs? 

The Hindenberg Omen and Time to Short Bonds?

Omens - A Comparison

All the chatter recently has been on the obscure Hindenberg Omen signal, flashed on Aug 12 and confirmed a few days later.  Let's take a closer look at this signal and see what it represents about this market and vs the most recent signal, which nearly led to a financial collapse.  As reference, the signal predicts a down market and is accurate 77% of the time, and ends in about 40 days.  It was discovered back in the 1950's, and a market crash has ALWAYS been preceded by a Hindenberg Omen.  First, let's look at the criteria:

1. The daily number of NYSE new Highs and Lows must both be greater than 2.2 percent of the total issues traded, which today equaled 67.
2. The smaller of the two must be greater than 75.
3. The NYSE 10-week moving average must be rising.
4. The McClellan Oscillator must be negative.
5. The new highs cannot be more than twice the number of new lows.

These all occurred for a second time this past Friday.  If you go down the list we see signs of market weakness (divergences galore), so it's no wonder the market breaks down.  I suppose we could look at other triggers too, but this seems to work well.  The question, is it more about psychology, a 'fait accompli' or Murphy's Law?  Probably a little of all three.  I want to see how the recent signal compares with the prior one in 2008.

The Omen I - 2008

In 2008 we saw two signals flash:  one in late June that ended around mid August.  It brought the markets down about 5% in the six-week period.  This was following the Bear Stearns debacle and just prior to the financial crisis getting serious.  Housing prices started to come down and banks were shaking.  Clearly business disruptions were there as the markets were about to embark on a nuclear winter.  Yield spreads blew out and credit default swaps soared.  However, bonds had yet to move...but that would be next.  The Fed was way behind the curve.  The second signal came in October, just following a big hit of Lehman and AIG.  We've heard all the stories that seemed to leave a desolate wasteland.  Bailouts, TARP, HAMP, ZIRP...all seemed to provide some temporary help.  Business seemed to ground to a screeching halt, not unlike what was seen after 9/11.  Yet, the second Omen signal was strong and worked well...a nearly 10% drop for the markets before the signal ended.  Perhaps the second signal is stronger than the first one, or perhaps it's just the timing.

2008 VIX Chart


The Omen II - 2010

Mid August gave us an Omen signal, but

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