As we approach a UK decision traders are getting less worried. Traders, as seen by VIX coming down expect less volatility. Less volatility is usually associated with the expectation for up markets. That said, the vote is far from decided. We think a sell the news event could be setting up, regardless of the outcome.
VIX shows complacency building into a risk event
Here's the VIX.
You can see that although last week the VIX jumped, this week it's been gradually coming back down. As we approach the UK decision traders are acting like they are less worried. But the vote appears to be a dead heat. We think the market, based on comparing VIX to the polls, is underpricing risk.
Here is VIX volume as seen by the ETF (NYSEARCA:VXX).
You can see the volume is coming back down after jumping last week. Traders were worried last week. This week they are less worried.
It could be that traders see the market going up and are calmed by the sheer market action. We think, however, that the market volume has dried up somewhat this week and so action is not the best gauge.
Market Up On Lighter Volume
Here's S&P 500 ETF (NYSEARCA:SPY) volume slowing this week.
But we'd point out that when the market goes down volume picks up. We think that is the hint that more people really want to sell.
You can see here that volume, although lighter, generally picks up on the downside.
Trader Thinking Going In
We'd guess that most traders don't believe that a Brexit will actually take place. Of those that think it is a possibility, many think the event is over-hyped and will not do anything to markets.
Therefore a trader, we believe, likely expects this to be an up event but wants to sell into strength anyway because the economy is showing more and more weakness.
But If The Market Doesn't Trade Up, Or doesn't hold...
Based on the VIX and volume, we think traders are expecting the UK vote will lead to an up event. The Fed, governments and banks expect, however, it to be a "risk" (down) event.
Sell The News Event
If so many think it's going up and plan to sell on the event anyway. For that main reason, it's setting up to be a sell the news event.
If the event does not trade up, this set up could exacerbate downside.
If VIX were trading up into the UK decision...
If VIX were darting up this week, we wouldn't have the same tune, necessarily. That scenario would mean most ARE worried about the risk of the event and so there will be more natural support in short covering regardless of the decision.
But it's not, which is why we think most are showing their cards that they "don't believe the hype."
Fundamentals, we think, are causing a sell anyway
If traders are waiting for the decision, we think they are waiting to ultimately sell positions. The Fed visit to congress was downbeat. The economy has been slowing. Election risk builds and its news could distract consumers as well.
We think the Federal Reserve is not raising their balances and so are not increasing liquidity to the system (We showed this here). We think because of this, like over the last year and a half, the market is capped on the upside, but has proven to go down big on the downside.
This formation has set up ever since the Fed stopped increasing liquidity to the market.
We think we are closer to the highs than the lows of this range, which is a poor risk/reward.
We think the data is showing what side of the fence traders are stacking up into the UK decision. We think, despite what we see, the event holds incredible risk. We think the VIX is a mismatch to the level of potential risk. For this reason and the slowing economy, we think this may set up to be a "sell the news" event regardless of the vote.
Good luck and please be in touch. All of your comments teach US a ton.
Elazar Advisors, LLC specializes in earnings and predicts, analyzes and reacts to earnings and earnings events as well as developing current company and macro stories with a hedge fund perspective.
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