Coming into this past Monday I was heavily influenced by three traders I follow on twitter who went long the previous Friday. I was curious what they saw that I was missing and it wasn't immediately apparent so I put it on the back burner to stew –occasionally stirring. If it wasn't for their influence upon me I would have started the week off in a much more bearish mindset, but their decision to expose themselves long in addition to their stature got me thinking I might be missing something bigger and is in part why I opted to expose myself long early in the week.
Nothing clicked through most of the week and I was uber-curious about the psychological shift in direction of these traders who I've come to have a healthy respect for. What cues where they picking up from the market that I wasn't attuned with? In the process of writing up this weekend's market analysis I reviewed some previous notes in which I was chalking and charting a key pivot for a while, but really didn't place this into a proper context and didn't connect the dots to a suitable reference to place it within.
While I'll get to the subtext in a moment, first a little digression. Technical patterns dictate that a new uptrend commences when there is a series of higher highs and higher lows. A rally off of a correction in turn would commence with establishing a pivot low and thereafter a series of lower highs and higher lows. In this context last Friday's price broke a key pivot inflection point which would in turn alert one to the the potential of a new up trend since this indicates the first stage of one.
Given that there's been a 10% correction thus far which in historical context is not unusual by any means but is significant in so far as a drop further becomes statistically rarer and hence less probable, one should also become more bullishly biased; further after a drop of this magnitude the immediate response should be to begin looking for behavior and characteristics of a new rally break to trade and again the first indication one is occurring is establishing a new lower high.
Also, catching the market after a rally break off of a bottom offers the best risk/reward ratio. If the timing is correct then there is only profit extraction to focus upon and if this turns out to be a false bottom risk management and positions size helps neutralize the down side risk.
What finally began to click is when I contextualized a few pieces of information and placed them into a narrative that I understood and could expound upon, however far fetched it might be. Behaviorally the human mind begins to note patterns after a sequence of 2 data points and this is evident in standard technical analysis which looks for confirmation of an uptrend once a second higher low and lower (or higher) high is established. This alone did not fully explain to me why they would begin to trade this week since it was only one, but there's another behavioral pattern that assisted.
Once the new lower high was established the effect of anticipation of anticipation took hold. Behaviorally we will not only anticipate an event or outcome, the anticipation can have such a strong influence upon us that we'll actually anticipate this anticipation. So even though the new uptrend has not been established by technical means, which is simply a two step sequence from which we'll begin to expect a third continuation of, this expectation may occur much earlier in the cycle, after the first one is established.
I have little idea if this is exactly what transpired or not, but I do know that I was influenced and that is in part why I also made it a point last week to stick on point and filter the news driven catalyst through a narrow focus of historical volatility, market breadth and charts.
So, now that my thought exercise for the week is resolved, it's abundantly clear that the market is undergoing a fit of volatility like the terrible twos. There's a number of means of defining just exactly what is volatility so for this weeks chart I wanted to use 4 criteria. The number of 1% moves close over close, the number of intraday 2% moves from the high to the low, historical volatility measures and the separation of the 15 period moving average from the 30. The following chart is broken down in three periods, the market bottom in October, the run up from January through April, and the ensuing topping pattern thereafter.
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Trends that begin with rally breaks are not unlike motorcycles accelerating from a complete stop. Early stages of trends will be erratic but once velocity picks up they will begin to stabilize just as a motorcycle warbles slightly before reaching a sufficient velocity to be in a state of equilibrium and balance between rider and bike. However, if the speed off the line is too fast or acceleration beyond stability occurs then a state of instability occurs and a crash is sure to come. Additionally these psychics apply to deceleration as well when the rider puts their feet down to keep the bike upright just a decelerating trend with a persistent bid will remain in a state of balance but lacking support will topple over.
Further, at some point all trends end, and when viewed from this perspective what stands out is the velocity peak that occurred in late January. By mid April this spread turned negative which would have been an early warning that the trend was coming to an end and allow one to prepare accordingly. Coupling this perspective of a trend with historical volatility which began to cross over the .50 point in March gives a complete perspective of both volatility and velocity which can be used to compliment a trading plan.
The last indicator on the chart is the number of intraday 2% moves and close to close 1% moves. For sake of convenience I opted not to calculate days that met both of these requirements and instead simply listed the raw numbers. What is noteworthy from this perspective is that in a persistent uptrend there are not many of theses days, but when the market begins to chop they begin to occur with greater frequency and often in succession. This can be used to further clarify the market environment.
Taking all of this and completing the picture, we're currently in the initial stages of a rally attempt. Expectations would be confirmed if the recent pivot high is broken and in turn disproved if the low is broken and there is follow through to the downside. There's also been a positive cross of the 15/30 differential so a new uptrend as defined by this separation would be confirmed as long as it remained positive and the sustainability can be deduced from it's velocity with slow and steady being the preferred. Lastly, the number of moves of 1% or greater need to drop out of the picture for tradeable swings to set up with higher probability.
Markets move up, down, and a lot of the time sideways. Sometimes they are volatile and some times sedate. . Ultimately we trade our own market as we define it and see it and eventually I'd like to get to the point where the primary influence upon my trading decisions is only myself and avoid being swayed by any other opinion other then the once I've come to.
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