Looking for a Quick, Short, $SPY Bounce

My breadth indicators are suggesting a quick, short-lived bounce will soon be had, likely tomorrow.

I say quick and short-lived because the red line, the number of stocks above their 5 day moving average, has not dropped to levels which usually sustain a longer lasting bounce. To indicate a longer bounce is possible, I would like to see a reading of 600 or lower.

The indicator I use to signal that a bounce is imminent is the green line, which is a percent ranking of the number of declining stocks. It closed tonight just above 80, which is the threshold I use.

While I am looking for a bounce, some range-bound trading or consolidation on Friday can remove the trigger.

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Several high tight flags have dropped off of the list due to steep pullbacks. They will likely consolidate and make the list again in the future.

There is only one high tight flag for Thursday.

 

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The recent consolidation has slowed down the production of high tight flags. Tonight’s installment finds one existing pick still primed for takeoff and one new pick.

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We are watching two previous candidates who are still holding steady high and tight and one new pick.

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The breadth indicators that I use are near critical thresholds.

The red line is the number of stocks trading above their 5 day moving averages. Ideally this number would be less than 600. It closed this evening at 793.I use this indicator to signal a swing bounce, one that may last several days to a week.

The green line is a percent-rank calculation of the number of declining stocks. Ideally this number would be greater than 80. It closed tonight at 76. I use this indicator to signal how soon the bounce might occur. It can oscillate very quickly.

Should the market close lower tomorrow, it is likely that both of these indicator will be aligned. If so, I will expect the bounce to occur soon, as in a day or two, and I will be looking for the bounce to last for several days. Buying a lower close tomorrow may make a great swing trade.

A word of caution: Note the gray histogram in the middle pane. This is a proprietary measure of the number of stocks in an uptrend. It is slowly going lower and lower even though the market is going higher and higher. This pattern has been in play since the bottom in 2009. This is a bearish divergence and should not be ignored. Eventually, if there are not enough stocks in an uptrend, the market advance can not be sustained and a serious correction of -10% or more may occur. These divergences can last for a long time, so this is not something that can be prepared for tomorrow.

I have included a longer-term view below and have hand-drawn a trendline to illustrate the divergence.

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The High Tight Flag list is similar to the last list published. There is a sense that something must happen soon in the markets and this notion is reflected in a static HTF list.

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On Friday, August 17th, $VIX made a new 1000 day low. Financial journals broadcasted this event, and headlines such as this and this are making the rounds. What can we take away from these articles?

…the VIX has spent over half of its time over the past two decades (from 1992 through Tuesday) between 10-20. So the level it’s at today is very, very normal.

“Be careful if you think the VIX has nowhere to go but higher”….the VIX has a history of remaining depressed during long periods of time — like they did between 2004 and 2007 when stocks slowly drifted higher.

Okay, easy enough. What we are witnessing with $VIX is not abnormal, but that isn’t information isn’t specific enough to help traders and investors. Let’s break the $VIX history apart so that we have information that is actionable.

We are going to start by looking at what happens when $VIX crosses beneath various moving averages. It is currently trading beneath its 10, 20, 50, and 200 day moving averages. We would expect this with it making a new 1000 day low.

The rules are simple: Buy $SPY at Close when $VIX Closes Beneath its X Day Average.

$SPY Buy-n-Hold is calculated by taking all $SPY history, breaking it into 50 day segments, and averaging the segments.

When $VIX is beneath the shorter (10, 20) moving averages, $SPY tends to track or slightly underperform its historical average performance.  This is likely due to short-term  mean reversion: as $VIX dips and stretches farther beneath the shorter moving average it will reverse for a brief period of time.

When $VIX is beneath the longer (50, 200) moving averages, $SPY tends to outperform its historical average performance. As $VIX stretches farther and farther beneath these longer-term averages, $SPY has tended to trend higher in a low volatility environment, enabling the outperformance.

Let’s dig deeper and look at the percentage of winning trades.

There have been 69 trades made¹ when $VIX crosses beneath its 50 day average. 68.12% of those were higher after 50 days.

There have been 55 trades made when $VIX crosses beneath its 200 day average. 60% of those were higher after 50 days.

The bottom line is that when $VIX  is beneath its longer-term moving averages, $SPY has tended to outperform its historical average performance and there is a better than average chance that $SPY will be higher 50 days later.

The next post will look at what has happened after $VIX has made a new X day low.

¹Trades held the full 50 days. There are more than 69 trades made if each is not held the full 50 days.

 

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