The Truth, The Light, And The Way

Random Thoughts

As mentioned recently, the short-term volatility of the market basis the Ps (S&P 500) has compressed to extremely low levels. Like a spring, volatility tends to bounce back after it is compressed and vice versa—it then springs back. Volatility can be more cyclical than price. It waxes and wanes. Unfortunately, volatility readings do not predict price direction. There are some useful and interesting nuances that can occur though. One of these is that price can often have a “fake out” move when volatility begins to expand. This traps players who think the market is obviously breaking out (or breaking down). The trade is then when the price comes back in.

Considering the above, my hope was that we would see a fakeout to the downside, in the spirit of a Trend Knockout (TKO)—just enough to shake out the “Nervous Nellies.” We did see a slight expansion in volatility on Tuesday but the readings are still very low. So, it’s too soon to make a directional bet based on price combined with volatility at this juncture. At this point, just brace for more volatility.

Now, let’s get back to my favorite subject, price. Price is the truth, the light, and the way. It helps to know things like the potential of the aforementioned fakeout, but for the most part, you want to pay attention to price.

With that said, the Ps woke up a bit, tacking on just over ½%–plenty enough to keep them at all-time highs. Maybe we’ll get lucky and this will turn into the mother of all breakouts and it won’t look back. I dunno. Take things one day at a time. You certainly don’t want to fight it.

The Quack (Nasdaq) had a decent day, tacking on well over ½%. This action puts it at 14-year highs.

The Rusty (IWM) had an okay day, gaining just over ½%. Unfortunately, it is still trading below where it was a week or so ago. Take things one day at a time here too. A few more half percents and it will also be approaching new highs.

The sector action was very good on Tuesday. As you would expect with the overall market at new highs, many  areas followed suit.

Drugs banged out new highs with a vengeance, tacking on over 1 3/4%. The Biotech subsector here didn’t make it back to new highs but had a decent day nonetheless—gaining more than the sector overall.

Health Services blasted higher to close at all-time highs.

I have been a little concerned about the lack of recent follow through in the Semis. There were no worries yesterday though, they broke out nicely to multi-month highs and they are just shy of multi-year highs.

Gold and Silver stocks continued sharply higher from their lows. This conflicts with my constant preaching of why you should not try to pick bottoms. Just keep in mind that the market can be a very bad teacher. It did work (so far) this time, but it hasn’t worked for many months. As usual, wait for setups. As a trend follower, you will be a little late to the party. I’ll discuss this along with should you by options that “never expire?” in Thursday’s chart show.

So what do we do? I’m seeing a few shorts setting up but that’s normal. Not every area always joins in. Based on the fact that the market is at new highs, I wouldn’t fight the tape. On the long side, I’m seeing a few setups in more speculative areas like the Rare Earths, Biotech, and IPOs. Therefore, focus on those areas for now. The good news about these so called “high beta” areas is that they can often trade independently of the indices. Therefore, sometimes you prosper even when you don’t get the overall market direction right. In general, there’s not a whole lot of setups just yet. This makes perfect sense since the methodology requires a pullback—and the market is at new highs.

Best of luck with your trading today!

Dave