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Jeff Pierce
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I’m a swing trader of momentum stocks with a holding period of anywhere from a few hours to a few months. I run a number of screens to locate the strongest/weakest stocks out there, using technical analysis to determine my entries and exits. Trying to calculate the intrinsic value of stocks in... More
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tradewithZEN
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  • The Markets Are On Borrowed Time

    By Poly

    The Equities markets continue to operate in a vacuum, nothing appears to concern these markets. The level of complacency and the lack of fear are astounding; any threat to the market is quickly discounted or ignored. But the lack of retail participation and generally below average sentiment suggests that this is not necessarily a speculative market. Equities are being driven by the market makers and high frequency traders, and this is evident from the near mechanical nature of this advance.

    Take a look at the below Daily chart, its near perfect form suggests that "bots" rule this market, "the tape has been painted". It's not like the backdrop or fundamentals for the equity market warrant such a fearless rally. Most of the world economies are in recession while in the US we have a mixed bag of weak to flat announcements. Valuations are historically rich and pricing in robust growth, but of the companies issuing early earnings guidance, 80% of them have been negative (88 out of 110).

    However fearless the markets are, they are now on borrowed time. The Daily Cycle is on Day 33 and well above its 10 and 20 dma, so the odds greatly favor that this Cycle is about to top and begin the decline into a DCL. Of course there are instances of Cycles running into the 40 plus day count before topping, but they are fairly rare.

    Looking further out towards the Investor Cycle and it's a similar story. The below chart (courtesy Bespoke Investment Group) shows just how far and extended this market has gone. This move is now more than 2 standard deviations above its 50 day moving average. Whenever these peaks occur deep in the Investor Cycle, they very often signal that the Cycle has topped.

    This Cycle has added 25% and is still making new highs in week 21. The rally has obviously been very impressive and places it into the top 10% of best performing Investor Cycles. But all great things must also come to an end eventually. There are just so few Cycles that have the ability to continue powering these types of moves beyond the 20 week mark. Because we're deep in the timing band for a Daily Cycle Top, the expectation is that the Daily Cycle will turn lower at any moment.

    This as is an excerpt from the weekend's premium update from the The Financial Tap, which is dedicated to helping people learn to grow into successful investors by providing cycle research on multiple markets delivered twice weekly, as well as real time trade alerts to profit from market inefficiencies.

    They offer a FREE 15-day trial where you'll receive complete access to the entire site. Coupon code (NYSE:ZEN) saves you 15%.

    Related Posts:

    Negative Divergences Setting Up S&P

    Gold Volatility Index Back To Bull Market Lows

    US Dollar Continues To Find A Bid

    Apr 18 2:04 PM | Link | Comment!
  • Lottery Fever Infects Stocks And Options

    By Chris Ebert

    Option Index Summary

    All markets become irrational from time to time, including the stock market. An irrational market can be extremely frustrating for traders. It's frustrating because an irrational market is driven primarily by emotions.

    Take the current market for example: While there are many factors that led to the recent all-time highs for the Dow and the S&P, one of the biggest factors is a form of "lottery fever". Just as increasing lottery jackpots tend to increase demand for lottery tickets, which in turn causes an increase in the jackpot, and so on… and so on… increasing stock prices sometimes are themselves a driving influence that causes subsequent increasing stock prices.

    With record highs making headlines on the evening news, folks who have shied away from stocks for years or decades are now likely to reconsider. And who can blame them? However, a considerable portion of the funds now beginning to pour back in to stocks through retirement accounts such as 401Ks or IRAs or through online brokerage accounts are not suddenly being allocated to stocks because of signs of a fundamental shift towards a more robust economy. Instead, they are being allocated towards stocks because of lottery fever.

    A healthy market needs to correct itself occasionally. Corrections help define levels of support and resistance, and thus help traders feel more confident. Confident traders help keep bull market rallies running strong. But lottery fever tends to disrupt the normal correction cycle. What we are left with is a market that is overdue for a correction. The recent rally is running on borrowed time, supported mostly by the presence of lottery fever.

    How long lottery fever will last is anybody's guess, but its presence can be monitored by the Long Straddle/Strangle Index (LSSI). Whenever the LSSI is elevated in an uptrend, it is an indication that buyers are entering the market based on their emotions; they don't want to miss out on the stock market lottery. The LSSI has been at abnormally high levels since March 9th.

    Often a correction of 10% or so ensues within weeks, once the LSSI reaches such high levels. However, lottery fever can postpone a correction for many weeks, and sometimes as long as a few months. To look at it another way, whenever the LSSI is elevated, the market is being irrational. This can be very frustrating for traders, because fighting an irrational market can be devastating. A famous economist once said:

    "The market can remain irrational a lot longer than you or I can remain solvent."

    To illustrate just how uncommon the current condition of the market actually is, consider 5 traders, each using a different option strategy. Each trader opened a trade 112 days ago (December 21, 2012) using at-the-money options on the S&P 500 using an ETF known as the SPDR S&P 500 ETF (NYSEARCA:SPY). This particular ETF maintains a share price that is approximately 1/10th the value of the S&P 500. On December 21, the S&P was 1430 and SPY was trading at $143. At-the-money options (those at the $143 strike price) expiring this week had a premium of approximately $6 per share at that time.

    • Trader #1 sold covered calls on SPY at the $143 strike for $6 per share.
    • Trader #2 sold naked puts on SPY at the $143 strike for $6 per share.
    • Trader #3 bought a call from Trader #1 at $6 per share.
    • Trader #4 bought 100 shares of SPY at $143 and also a put from Trader #2 at $6 per share.
    • Trader #5 bought a call from Trader #1 and a put from Trader #2 for a total of $12 per share.

    When all of the above options expired this week, the S&P was near 1589, so the share price of SPY was about $159.

    • Trader #1 sold all shares of SPY at $143 as obligated by the call option, which is a wash, but kept the $6 per share premium as profit. That works out to a gain of about 4% relative to the original share price of $143.
    • Trader #2 had the naked puts expire worthless, and kept the $6 per share premium as profit. That works out to a gain of about 4% relative to the original share price of $143.
    • Trader #3 exercised the call option which granted the right to buy SPY shares at $143, and then sold those shares immediately for $159. The $6 per share premium is added to the cost basis of the shares, and the end result is a $10 per share profit. That's a gain of about 7% relative to the original $143 share price.
    • Trader #4 had a put option that expired worthless, so the $6 per share premium is added to the cost basis of the shares, and the end result is a profit of $10 per share when the shares are sold for $159. That's a gain of about 7% relative to the original $143 share price.
    • Trader #5 had a put option that expired worthless, but exercised the call option which granted the right to buy SPY shares at $143, and then sold those shares immediately for $159. The $12 per share in option premiums is added to the cost basis of the shares, and the end result is still a $4 per share profit. That's a gain of about 3% relative to the original $143 share price.

    Everybody made a profit! The covered call trader, the naked put trader, the long call trader, the married put trader and the long straddle trader each made a profit. That's not something that happens very often, and it is often a sign of an irrational market.

    Each of the above trades may be monitored in order to gain insight into the stock market. The Covered Call/Naked Put Index (CCNPI) tracks the profitability of covered calls (Trader #1) and naked puts (Trader #2). The Long Call/Married Put Index tracks the profitability of long calls (Trader #3) and married puts (Trader #4). The Long Straddle/Strangle Index tracks the profitability of combined long calls and puts (Trader #5). The detailed 3-step process of analysis is shown below:

    STEP 1: Are the Bulls in control of the market?

    The performance of Covered Calls and Naked Puts reveals whether the Bulls are in control. The Covered Call/Naked Put Index (CCNPI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames. Most important is the profitability of these trades opened 112 days prior to expiration.

    (click to enlarge)

    This week, covered call trading and naked put trading were both profitable, as they have been for an extended period. That means the Bulls remain in control. The reasoning goes as follows:

    • "If I can sell an at-the-money covered call or a naked put and make a profit, then prices have either been going up, or have not fallen significantly." Either way, it's a Bull market.
    • "If I can't collect enough of a premium on a covered call or naked put to earn a profit, it means prices are falling too fast. If implied volatility increases, as measured by indicators such as the VIX, the premiums I collect will increase as well. If the higher premiums are insufficient to offset my losses, the Bulls have lost control." It's a Bear market.

    STEP 2: How strong are the Bulls?

    The performance of Long Calls and Married Puts reveals whether bullish traders' confidence is strong or weak. The Long Call/Married Put Index (LCMPI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames. Most important is the profitability of these trades opened 112 days prior to expiration.

    (click to enlarge)

    This week, long call trading and married put trading were both profitable. Both forms of trading became profitable in late January. It means the Bulls are not only in control now, but they are confident and strong. The reasoning goes as follows:

    • "If I can pay the premium on an at-the-money long call or a married put and still manage to earn a profit, then prices have been going up - and going up quickly." The Bulls are not just in control, but they are showing their strength.
    • "If I pay the premium on a long call or a married put and fail to earn a profit, then prices have either gone down, or have not risen significantly." Either way, if the Bulls are in control they are not showing their strength.

    STEP 3: Have the Bulls overstepped their authority?

    The performance of Long Straddles and Strangles reveals whether traders feel the market is normal, has come too far and needs to correct, or has not moved far enough and needs to break out of its current range. The Long Straddle/Strangle Index (LSSI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames. Most important is the profitability of these trades opened 112 days prior to expiration.

    (click to enlarge)

    On March 9th, long straddle trading and long strangle trading reached rare and absurd levels of profitability. Such levels normally precede a correction. That does not preclude a possible move higher prior to the correction though.

    Just because the LSSI is warning of an upcoming correction does not necessarily mean that this is a good time to go short. It just means that the market cannot continue at its current pace without running out of buyers. Often a correction occurs within a week of the LSSI exceeding 4%, but there are times when the market tacks on several weeks of large gains before it corrects.

    Since March 9th the market has indeed tacked on several weeks of impressive gains, with the Dow and the S&P both reaching new all-time highs. Is the current market irrational? Yes. Is such irrational behavior unexpected? Not at all. Every market goes through phases of irrationality, and each phase eventually ends with a reversion to more rational behavior.

    While the LSSI is a strong indicator of upcoming corrections, usually within weeks, there are also times when corrections occur several months after the initial LSSI signal. That does not mean the LSSI was wrong. Can anyone honestly say they would not welcome a sell-off at this point, if for no other reason than to buy the dip?

    The current market is well overdue for a correction. The current rally is living on borrowed time. The correction will occur, eventually, but betting on a correction could potentially lead to bankruptcy. An elevated LSSI has always led to a correction in the past, and there's no reason to suspect this time will be an exception. It's just a matter of how long until it occurs. The reasoning goes as follows:

    • "If I can pay the premium, not just on an at-the-money call, but also on an at-the-money put and still manage to earn a profit, then prices have not only been going up quickly, but have gone up surprisingly fast." Profits warrant concern that the market may be becoming over-extended, but generally profits of less than 4% do not indicate an immediate threat of a correction.
    • "If I can pay both premiums and earn a profit of more than 4%, then the pace of the uptrend has been ridiculous and unsustainable." No matter how much strength the Bulls have, they have pushed the market too far, too fast, and it needs to correct

    Conclusion

    The CCNPI currently indicates a bull market and the LCMPI confirms that the bull market has strength. But the LSSI presents a reason to be cautious. Levels of the LSSI that have been reached in the last five weeks often precede a significant short- to intermediate-term correction in the S&P.

    The current rally is living on borrowed time, and yet it shows no signs of giving up. Everyone knows a correction is on the horizon, and still the correction has not been ensued. If there is any comfort for those waiting impatiently for the next correction, the longer it has taken for a correction to begin after a signal from the LSSI, the deeper that correction has historically been.

    *Option position returns are extrapolated from historical data that, while reliable, cannot be guaranteed accurate. It is not possible to match the exact performances shown, because the strike prices and expiration dates used in the calculations will not always be available in actual trading. All data is relative to the S&P 500 index.

    The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book "Show Me Your Options!"

    Related Options Posts:

    Market's Thermostat Ain't Broken - So Says LSSI

    Option Indices Don't Just React, They Predict

    LSSI Is For Folks Tired Of Correction Crying Wolf

    Apr 18 2:03 PM | Link | Comment!
  • Pullback Is Buying Opportunity For USDJPY

    By Mike Ber

    The following is brought to you by ForexAlerts.ca who publish a premium daily newsletter outlining key support/resistance levels, and trading bias for 5 major currency pairs. Currently they are in pre-launch and are offering a 50% discount for those who subscribe now.

    In our previous article we discussed few of the factors that can prevent USD/JPY from rising in the short term. One of the factors we've mentioned was "currency war talk". Indeed, Chinese economists warned last weekend that devaluations carried by the Bank of Japan will hurt Asian economies, and the strong retaliation measures will be required to keep Chinese economy competitive. On Friday, late in the day, the US Treasury published its annual report on exchange and policy rates. According the released statement, Japan is advised by US to refrain from additional debasement of the Yen. USD/JPY retraced significantly following the release, and ended the week @ 98.37.

    We've recommended to our members two weeks ago to take profits @99.63 level of resistance. The pair made a new high last week and traded @99.90, but couldn't break physiologically important level of 100.

    Here is an excerpt from our Friday morning report: "USD/JPY is trading within the 97.80 - 102.421 range. We've changed our bias to Bullish-Neutral. Still unable to break the magic number of 100. If 100 is broken the next level of resistance will be @ 102.421. We are waiting for good opportunities to enter a long position. At this point we prefer to enter @97.80 (this level will fill the gap on the chart from last week).

    (click to enlarge)

    USD/JPY - 4 Hour Chart

    USDJPY is trading within the 97.80 - 99.719 range.

    The resent sell off was expected, because the pair was significantly overbought, and tried to break through 100 multiple times. We believe that the level of 97.80 will represent a good opportunity to start to scale back in. Further pull back can't be ruled out, but given the strength of USD/JPY charts there is a chance that we won't get more than a pull back to 97.80. The next level of support is 97.197. After that we expect the pair test the recent highs.

    (click to enlarge)

    EUR/JPY - 4 Hour Chart

    EUR/JPY is trading within the 127.299-130.803 range.

    We prefer to enter long positions in the 125.676 - 127.299 range, closer to 125.67. Out of the two pairs USD/JPY is relatively stronger, and that's why we prefer trading this pair more than EUR/JPY.

    Apr 15 5:06 AM | Link | Comment!
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