Sunday, August 23, 2015

Market Analysis for Week of 8/24/15

Big bad bull fall down go boom.  I think the official term inside the Fed is: uh-oh spaghetti-O's.  Is there anyone out there who is still in denial about the value of technicals?  Because there is no greater example than what just happened to stocks.  And I'm not here to pick fights with anyone.  There's a lot of different ways to trade.  All of them can work with the right risk control and trade management.  It will forever and always, with no exception, be about position size.  Everything else is a guide to help you make decisions and give you confidence to make a trade, or stay in a trade, or cut it loose.  Using technicals is not some holy grail of trading, but it IS grounded in the psychological positioning of the underlying players and it helps with timing and risk control because there are spots on the chart where your idea is either working or it's wrong.  Essentially, it helps to protect you from yourself.

There are people who subscribe to all kinds of traditional philosophies that involve numbers and data points and all kinds of information like valuations and cash flow and earnings per share, and I'm not criticizing that approach in the least.  I've always maintained that it's all about how you're wired and finding a method that works for you.  But disregarding technicals can get you in serious trouble.  In terms of using fundamentals, the biggest advantage of having a strong fundamental conviction is that it will keep you in a trade far longer than you would be normally.  But the biggest disadvantage of having a strong fundamental conviction is it will keep you in a trade far longer than you would be normally.

There's a lot of people who have a conscious or unconscious belief that equity prices will always go up in the long-term, so they just keep dollar cost averaging every week of their lives.   This belief gives them an insane tolerance to hold through vicious pullbacks and even market crashes.  It's kinda the philosophy of the entire industry.  And if you're looking at an equity chart a hundred years from now, they will likely be right to have that belief because the world's capital base grows over time as technology evolves.  But thanks to the loss of restraint in the money supply when the dollar lost its gold backing, and the Federal Reserve's ignorance of its own policies, we don't live in a buy-and-hold world anymore.  We live in a boom-and-bust world.  And while all the major stock indices just put in major technical topping patterns, I'm not suggesting this is THE generational top because most likely next year the Fed will be back in QE4.  However, it certainly could be, which is the whole point of respecting technicals in your decision making.   Nobody knows.

If you want to know if you're talking to a perma-bull or perma-bear, ask them at what price they consider their idea wrong.  If their eyes glaze over and steam comes out their ears like they never considered that possibility, you have a perma-view on your hands.  Those people are heroes when the market is moving their way because they hold through all the crazy pullbacks, but when the market turns they never see it coming.  And I'm not trying to be critical of perma-people either.  Whenever I talk in universal terms there's always someone who sees their reflection and thinks I'm talking about them, but what's actually happening is a subtle form of mental vanity, which is in everyone, that maintains the illusion of separateness by solidifying the walls of the ego through the perceived and self-created feeling of being personally attacked.  For the most part, I save all my criticism for politicians and central bankers.  Fuck them.  Other than that, what people do is between them and whatever you want to call the spiritual force that pervades this world.   My point about perma-people is those temptations exist within us - to be seduced by an idea of forever-ness, so you don't ever have to change or make hard decisions.  It's helpful to at least be aware when you might be under the influence of that temptation.  Sometimes objectivity is hard.  When you're under the influence of perma-thinking, you end up rationalizing away all the signs that were there all along if you weren't so blinded by your conviction.  Ideally, the place to be is right in the middle of self-doubt and conviction, constantly holding up your point of view to any new information that threatens its validity.  And have I mentioned in the last five seconds that it's always about position size?

I would also like to point out that the options market is always wrong when it matters most.  AFTER Thursday's big selloff (after!), which took us to the psychological edge of the technical cliff from an 8-month trading range, the expected move for the ES on Friday was 14 points.  And I'm also not trying to be critical of options pricing either, but it doesn't factor psychological inflection points into the prices.  And I get the whole systematic approach that over time the implied expected move will end up bigger than the realized expected move and you can capture the difference and moments like Friday are the outlier events on the distribution curve.  My point is there are times when you can reduce the number of outlier events you have to absorb by being aware that certain situations have a higher likelihood of blowing out the expected move because they are driven by the psychological pain point of a technical breakdown.  None of the approaches to trading refute any of the others.  Actually, I think combining them all creates a synergistic effect that puts you in the best possible position to maximize your chances for success.  However, even by combining fundamentals, technicals, and the expected move priced into options, all of that is only like 20% of the recipe for success.  At least 80% is the psychological battle of managing your emotions, which usually boils down to applying the proper position size at the proper time with the proper level of conviction.

Zero sum markets (futures, forex, and options) are essentially a wealth transfer mechanism from the weak hands to the strong hands.  And I'm not suggesting that account size is what determines the weakness of your hand.  It's actually leverage.  You can be a billion dollar hedge fund and turn yourself into a weaker hand than the guy with a ten thousand dollar account by using too much leverage - the wrong size at the wrong moment that creates a small window to be right and forces you out of the trade when it moves too much against you.  The wealth transfer happens as the market moves from one pain point to the next.  In order for the winners to make money they need to washout the losers.  What happened on Thursday and Friday in equities was a wealth transfer from the people who were long to the people who were short.  Less dramatic moves happen every single day to the short-term traders.  That's what stop runs are all about.  It's just a bunch of liquidity in one spot for profit taking by knocking out the weaker hands.  From what I read, that's how the pits used to work, and that's clearly how the algos are programmed.  That's why the market often reverses after a poke to a new high or low that runs the stops.  The sellers, or buyers, often cease because they just took profits by hitting those stops.

To illustrate how the psychological challenge is always what's most important, I'll tell you why I only did "ok" on this equity breakdown even though I saw it coming.  The reason can be boiled down to two words: options expiration.  For the last year and a half, the vast majority of my equity profits have come from OPEX short squeezes.  There's been at least 8 or 9 selloffs right before or early in the OPEX week that predictably reversed sharply, cut the heart out of the bears, and fed it to them with a side of fava beans.  It's been my favorite thing to do.  So, out of the 4 weeks of possible trading days both before and after this cycle, this breakdown HAD to come the last two days of options expiration, which totally messed with my mind.  Since I wasn't short from near the highs like I should have been, I was only emotionally capable of getting on a small short and every time there was a weak intraday bounce - that any other time I would have pounced on - I couldn't force myself to do it because I was afraid of being a victim of my favorite trade from the other direction, even though it was obviously not going to happen this time.  When I said think of the nastiest thing that could happen because that's likely to happen, I didn't think I would be included in the trickery.  Even if you controlled every tick of the market, you couldn't have designed a nastier unfolding of this breakdown than letting price spike up after the dovish Fed Minutes on Wed and then slamming it through major technical levels into a waterfall decline the last two days of expiration.  But that's trading.  Well done Shorty and the Shorters.

When I reflect on how I could have done it better, I feel like it was like one of those hands in poker you just can't get away from.  Have you ever lost with a 4-of-a-kind?   Or maybe more commonly, losing with a full-house?  When you think back on it, you realize there's no way I could have folded that hand.  It was "in the cards" that I was going to get knocked out.  So, the people who got PAID the most during this breakdown were the ones who've been suffering on the short side waiting for their ship to come in.  And good for them.   I could never trade that open-ended way myself because that kind of unending generalized anxiety would ruin my life.  I'd be walking around scowling at everyone, kicking puppies, and telling old ladies who want to cross the street to pound sand.  But the downside of the way I trade, which has to be more surgical in its timing, is instead of the constant annoyance and anxiety of wondering WHY people are STILL trading opposite of me and what the HELL are they thinking, my pain is more localized to moments when I don't get the timing right, whether that is missing the trade altogether, or being early, or just getting it wrong.  Then it's over without a single puppy kicked.  Big hedge funds can't trade like that because they're too big.  It takes days or weeks to build their positions, which greatly affects how prices move, so it's worth thinking the implications of that through, btw.

Regardless of the style, I would describe trading as the daily management of anxiety and disappointment with the occasional moment of pure joy and satisfaction, which is likely just the temporary absence of disappointment.  Not to mention the constant battle with the subtle force inside you trying to get you to go bigger, or just wait that loser out a little longer...   Greed and fear.  They will always be there, lurking.  Kinda like being an addict.  It's not something that goes away.  It's something that must be disciplined.  So, in that regard, I've come to respect the more systematic ways of trading with strict trade and money management rules.  I used to see it as too restricting, but I've come to realize it's like using technicals in the sense that the rules are there to protect you from yourself.  There are trades you're going to miss because they are outside your rules.  If they happen often enough and the risk/reward profile is favorable then you have to expand your rules to include that kind.  I will add, though, that there are moments when your rules should allow you to go big.   But it should require all the stars aligning in a special way.  If this wasn't options expiration week, this would have been one of those times for me.  What I've learned in my style of trading is that out of ten trades, 90% of the profits will come from one of them.  If the rest of the time I can just hang in there and scratch out a positive number, I'll do fine.  So it's not a big deal when an opportunity isn't maximized as there is always another one around the corner.

Not sure where that came from, but onto the charts.  Let's start with the ES.  In my opinion, the game just changed from BTFD to STFR.  I'm thinking a mechanism just got put into place that needs to work itself out over several months, unless, of course, the Fed realizes they're living in fantasy camp and commits to no rate increases for the rest of our time on Earth.

Most likely we need more selling first, but I'd bet my life once the first short covering rally comes that we test just shy of the neckline, which is at 2032-ish, or 2040 SPX, probably in the 2020s.  That's where Shorty and the Shorters will be looking to defend plus anyone who wants to get out from the long side.  If the panic selling continues on Monday, I'm looking to get to the 1930-ish area as a potential spot to be watching for bottoming signs because that's the range extension, but I don't really have a level per se.  What I'm looking for is a low to get put in and then a failed intraday test that creates a higher low, or preferably a stop run reversal.  The worst thing that could happen from the bottom is a big gap up and run.  That would make it hard to size up because you can't have confidence they won't run it down to the lows one more time to shake you out.

ES weekly.

The Fed has me all coiled up about this dollar/Euro trade.  If I believed the Fed was actually data dependent in their decision, then it wouldn't be hard to say they're never going to raise rates.  But it just hasn't sounded like that's what is driving their thinking, so it's way harder to figure out.  It's like trying to measure how crazy someone is.  There's no gauge for that.  I'm thinking if they have ANY intention of raising rates in Sept, they will signal those intentions at Jackson Hole this Thursday and Friday.  I originally thought Janet Yellen would do it, but it's going to be hard for her to pull off when she's not scheduled to be there, so maybe one of her minions will drop the hint one way or another.  Just f-ing commit to something.  That's all anyone wants.  If nothing comes from there, then they've done the worst possible job at communicating that I can possibly imagine, so you would have to think it's not gonna happen.

Dollar daily.

As for this dollar/Euro trade, I'm not surprised the Euro made it to the upper trendline of the triangle.  I grabbed a solid piece of it but the early Minutes release caused me to miss sizing up on this too.  Can we at least stick to the schedule people?  A guy can't hit the gym anymore?   Can I go to sleep or will NFP be released at some random time during the night?   I'm sure nobody benefited from that.

Check out this interesting difference in the Euro futures chart and the EURUSD chart on the weekly.  The futures show the Euro not breaking out yet but the forex shows it is.

Euro weekly.

EUR/USD weekly.

I don't know what to make of that, but I'm going to stick with the futures charts due to that's what I usually trade and both the dollar and Euro are in sync.  It's at an inflection point that will likely be resolved soon.

Gold hit its first downtrend line and backed off like $9.  Like the Euro, this is right where I want to short it, but with the Fed at such a critical juncture, it distorts the risk/reward, so I'm either going to wait, or keep it really small.  I would think there should be at least a small pullback this week.  The point of all these dollar related assets is they are all shaping up for a big move based on what happens with the Fed in Sept, which could be indicated earlier than that, but once there is some kind of catalyst these "should" all act accordingly and run.  That's why I don't think there's necessarily a hurry.  I'm usually talking on here about bigger moves to hold.  There's always short-term trades available.

Bonds are approaching the weekly upper channel.  I think the reason bonds didn't rally more on the equities selloff was because the dollar selloff kept them in check.  I can't see myself getting involved in bonds again for a long time.  There's just more technically sound charts to trade because it's too close to resistance that I don't want to deal with and I'm just not all that interested in the short side.  It's just not my thing.

Oil daily is still using the 10-day to keep the pressure on.  It should be noted that the Large Specs have liquidated somewhat but they are still heavily long oil.  I don't understand it myself, but it is what it is.  More downside fuel to shake out.  So if you're not already short, the Commercials aren't lifting their hedges and the Specs are already longed up, so there's no one to buy to create a bounce other than spec shorts covering.

Check out oil on the monthly forming an RSI divergence, which is just noteworthy at this point and could take awhile to play out, but it is something to keep an eye on.   I'm thinking oil will break the 2009 lows and force a capitulation, but I am concerned about a possible dollar breakdown causing a short-term rally first.  It should be noted, though, that oil hasn't flinched with the dollar coming off nearly $4 lately.  

This is what it's like being on the wrong side of the trade, every time you look at the computer screen:

And this is what it's like being on the right side of the trade.  Stole my moves: