The Dead Cat (SP500) Did Bounce Just As We Expected!

Stocks are pushing deep into a resistance level with very light volume… not a bullish sign. This is why we took profits yesterday with our SSO trade once we reached our dead cat bounce target of 2.5%. With it being Friday volume should only get lighter as the say progresses. I am starting to look at buying SDS as risk is low in my opinion but I’m going to let the morning play out first and re analyze in the afternoon.

Pre-Dead Cat Bounce Warning:

The rising market has sent the volatility index tumbling lower and this just goes to show why you must manage position and use protective stops. I know many of you were angry that I said to take partial profits and that we got stopped out yesterday on the VXX trade for a net gain of 2.9% in three days. Maybe one day emotional traders will see that you must trade with the market and adjust your trade outlook while in the trade. The market does not stop and wait for you to see the light, rather it will just steam roll you and never look back.

So with that being said I am starting to really like the VXX again for another buy signal. With any luck it could keep dropping for most of the session and we could go long this afternoon.

Crude oil is moving nicely in our favor today up another 2% on our 2x leveraged ETF’s. I am keeping my stop at breakeven for now as but that may change by the end of the day if we break the $109 level which is unlikely. Where to put your stops for any trade is always a tough call. It varies on the time frame, overall market condition and the size of your position so don’t think it’s just as simple s using the previous pivot high or low. That being said, those are good places for them if you have the timing correct or if the market co-operates with you…

*One key thing to point out today, the dollar bounced off support which is what I warned about last night and again this morning in pre-market. The strong bounce in the dollar has not caused any selling in oil or stocks this morning. I think that is based on the strong jobs report this morning. More jobs means businesses should be getting stronger and the more gas/oil will be consumed. But if the dollar keeps on moving higher and breaks above this key resistance level in the next few trading sessions then it will likely cause selling in stocks. Oil may hold up because demand will still be there.

Let’s see how this week unfolds!

Chris Vermeulen – Get our free Trade Ideas at Technical Traders.Com

The U.S. Dollar and Crude Oil Hold Clues About The Future

The past few months have been a difficult environment for anyone that was bearish. The next few months may prove to be difficult for everyone regardless of directional bias.

We live in a world where headlines can move the market in split seconds as high-frequency trading robots cause flash rally’s and flash crashes regularly.

As an example, the price action in the Market Vectors Short Muni Index (SMB) on February 28^th demonstrates the impact that these high frequency traders have on illiquid underlying assets.

We certainly hope there were not any absent minded retail investors that got caught using market orders during the flash rally only to recognize losses as great as 5% or more in a matter of minutes.

The following chart illustrates a flash rally and the monster 40% plus rally witnessed in less than 1 minute. Can someone say fat finger mistake?

Market Vectors Short Muni Index 1-Minute Chart

In addition to high frequency trading, we have to constantly monitor the headlines coming out of Europe as one event or official statement has the potential to cause the Euro to rally or selloff almost instantly whether the information is fact or fiction.

We have traded small for the most part during the beginning of 2012 as market conditions have been volatile even if the volatility index (VIX) has not necessarily supported that view.

One after another, perma-bears have capitulated to the bullish camp and now we have pundits calling for the Dow Jones Industrial Average to move over 15,000 by the end of the year.

We both use strategies which in many cases would be considered contrarian by nature. Admittedly we will not get every move in the market correct, but what we will do is layout key areas that price action should migrate to in the form of key price levels across short, intermediate, and long term time frames.

Our objective is to provide readers and our members with actionable information which can be viewed objectively by both bulls and bears alike. With that said, the following viewpoint we have of the marketplace today runs contrary to the collective group of market pundits.

While most market pundits expect higher prices and stronger economic data, there is reason to believe that recent developments could be indicating that volatility may lurk ahead. Volatility could rise up and push equity valuations lower in the near term.

The daily chart of the Ipath S&P 500 VIX Short-Term Futures ETF (VXX) shown below illustrates that the VXX has seen strong volume in the past few weeks. Additionally the VXX appears to be trying to form a bottom.

With volatility at these levels, put protection is cheap and it would appear based on volume that the smart money is getting long volatility. Long VXX trades are designed to either act as a portfolio hedge or as a potential profit mechanism should a correction play out.

Ipath S&P 500 VIX Short-Term Futures (VXX) Daily Chart

By now most readers are aware of the rally that has been taking place in oil futures for the past few weeks. Nancy Pelosi came out with a statement blaming those evil speculators again while Republican Presidential hopefuls used higher oil prices as another key political topic against the current administration.

Just when the noise was starting to rise to a roar, the marketplace was quieted by a rally in the U.S. Dollar on February 29^th. The daily chart of the Dollar Index futures is shown below.

Dollar Index Futures Daily Chart

Do readers find it rather odd that just about the time when oil was on the lips of every media personality in the United States that the Federal Reserve issues a reverse-repo to pull in liquidity? Do you find it at all coincidental or could it be that Mr. Bernanke was told to slow down the rally in oil prices?

After the reverse-repo was performed, the Dollar soared higher and was showing continuation to the upside on Friday afternoon during intraday trade. The Dollar is potentially forming a bottom presently and the fact that the Federal Reserve is aiding in that formation presents additional risk for downside in the S&P 500 Index and precious metals in the near term.

For the past several weeks the U.S. Dollar Index has pulled back and the S&P 500 definitely took notice. However, the Dollar is on the verge of carving out a weekly swing low which could have legs to much higher prices.

While many pundits routinely mock the Dollar and trash it, in the event of a major currency or credit event in Europe the Dollar will be one of the key safe havens that large sums of wealth will migrate too.

If the Dollar Index Futures can push through the downtrend line illustrated on the chart above with strong supporting volume a much larger move higher will likely play out. Should that scenario play out, the S&P 500 Index will likely begin to rollover.

It should be noted that the S&P 500 has struggled on multiple occasions to break above the key 2011 highs. The S&P 500 Index daily chart below demonstrates the resistance directly above current price action.

S&P 500 Index Daily Chart

We have been bearish on the S&P 500 since price was testing the 1,330 price level. After the subsequent breakout we targeted the key 2011 highs as a last stand for the bears. If the Dollar finds a bottom and rallies sharply higher from current levels a correction in the S&P 500 will likely play out.

The other possibility would be a breakout over current resistance levels which would likely see the S&P 500 move to the 1,400 level if not higher in a matter of a few weeks. We are not leaning in either direction in terms of price action currently, but we are expecting the VIX to move higher in coming weeks and months ahead.

In our most recent collaborative missive, we discussed the fundamental case for gold prices going higher over the long term. Cleary the price action this week (specifically the price action on Wednesday February 29^th) has been bearish and we expect to see prices chop around with a potentially bearish view for the next few months.

Gold Futures Daily Chart

While gold has pulled back sharply, the likely move lower in coming weeks and months ahead will offer a strong buying opportunity for investors that are patient. If the Dollar breaks out to the upside which we anticipate, gold should move down into a significant low.

Should this scenario play out an entry point near the low will likely offer strong upside potential. In fact, it might be the last deep low before a prolonged period of choppy price action until the Dollar tops.

We firmly believe that as long as central banks continue to print money with wreckless abandon, the fundamental case for gold remains quite strong in the longer term.

We have received a lot of emails recently asking about our opinions on the future price action in oil. Even though the Dollar may breakout to the upside, oil has a risk premium built into the price already for potential geopolitical conflict. However, military action in the Middle East could easily push prices higher.

Should oil push higher and test the 2011 highs and breakout to the upside, the likely results will be a weakening in the domestic economy as gasoline and diesel prices would surge higher. A surge in oil prices has a direct implication to the domestic U.S. economy as the cost for nearly everything will rise. 

The daily chart of oil futures is shown below.

Oil Futures Daily Chart

Conclusion for what to expect next:

Ultimately we believe the two most critical assets to monitor at this time are the U.S. Dollar and oil futures. The U.S. domestic economy cannot handle significantly higher oil prices from the current levels without seeing business growth slow. Furthermore, if the Dollar rallies it could put pressure on the equity markets as well.

While the equity markets and the economy are not the same thing, it is important to note that higher oil prices at a certain point will become equity negative.

The VIX is sending a warning that market participants are too complacent and the Dollar is potentially forming a rounded out bottom. These two conditions paired with geopolitical risk in the Middle East represent additional risks to economic growth.

Furthermore, market participants cannot become complacent regarding the potential risk that Europe still poses. With the various risks listed above in mind, we are keeping position sizes small and are attempting to remain Delta neutral in our portfolios. Risk is beginning to elevate to extremes.

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Volatility Bounces Bottom Awaiting Bad News or Selling to Strike!

Over the past 5 months we have seen volatility steadily decline as stocks and commodities rise in value. The 65% drop in the volatility index is now trading at a level which has triggered many selloffs in the stock market over the years as investors become more and more comfortable and greedy with rising stock prices.

Looking at the market from a HERD mentality and seeing everyone run to buy more stocks for their portfolio has me on edge. We could see a strong wave of fear/selling hit the S&P 500 Index over the next two weeks catching the masses with their hand in the cookie jar ........ again.

If you don’t know what the volatility index (VIX) is, then think of it as the fear index. It tells us how fearful/uncertain investors are or how complacent they are with rising stock prices. Additionally a rising VIX also demonstrates how certain the herd is that higher prices should continue.

The chart below shows this fear index on top with the SP500 index below and the correlation between the two underlying assets. Just remember the phrase “When the VIX is low it’s time to GO, When the VIX is high it’s time to BUY”.

Additionally the Volatility Index prices in fear for the next 30 days so do not be looking at this for big picture analysis. Fear happens very quickly and turns on a dime so it should only be used for short term trading, generally 3-15 days.

Volatility Index and SP500 Correlation & Forecast Daily Chart:

Global Issues Continue To Grow But What Will Spark Global Fear?

Everyone has to admit the stock market has been on fire since the October lows of last year with the S&P 500 Index trading up over 26%. It has been a great run, but is it about to end? Where should investors focus on putting their money? Dividend stocks, bonds, gold, or just sit in cash for the time being?

I may be able to help you figure that out.

Below is a chart of the Volatility index and the gold exchange traded fund which tracks the price of gold bullion. Notice how when fear is just starting to ramp up gold tends to be a neutral or a little weak but not long after investors start selling their shares of securities we see money flow into the shiny yellow safe haven.

Gold & Fear Go Hand In Hand: Daily Chart

Looking at the relationship between investor fear/uncertainty and gold you will notice scared money has a tendency to move out of stocks and into safe havens.

Trading Conclusion Looking Forward 3 months…

In short, I feel the financial markets overall (stocks, commodities, and currencies) are going to start seeing a rise in volatility meaning larger daily swings which inherently increased overall downside risk to portfolios and all open positions.

To give you a really basic example of how risk increases, look at the daily potential risk the SP500 can have during different VIX price levels:

Volatility index under 20.00 Low Risk: Expect up to 1% price gaps at 9:30am ET, and up to 5% corrections from a previous high.

Volatility index between 20 – 30 Medium Risk: Expect up to 2% price gaps at 9:30am ET, and up to 15% corrections from recent market tops or bottoms.

Volatility index over 30 High Risk: Expect 3+% price gaps at 9:30am ET, and possibly another 5-15% correction from the previous VIX reading at Medium Risk

Note on price gaps: If you don’t know what I am talking about a price gap is simply the difference between the previous day’s close at 4:00pm ET and the opening price at 9:30am ET.

To continue on my market outlook, I feel the stock market will trade sideways or possibly grind higher for the next 1-2 weeks, during this time volatility should trade flat or slightly higher because it is already trading at a historically low level. It is just a matter of time before some bad news hits the market or sellers start to apply pressure and either of these will send the fear index higher.

I hope you found this info useful and if you would like to get these reports free every week delivered to your inbox be sure to visit here to join my FREE NEWSLETTER!

Chris Vermeulen

What To Expect in the Final Week Of February for Precious Metals, Gold Stocks & Dollar

This morning we are seeing the US Dollar index move higher retesting a short term breakdown resistance level. What this means is that the dollar fell below support and is not slowing drifting back up to test the breakdown level. As we all know once a support level is broken it then becomes resistance. So if that holds true with the current move in the dollar we should see stocks and commodities find a short term bottom and continue higher today or tomorrow from the looks of things.

Gold has been pulling back the past couple trading session on light volume which healthy price action. It has done the opposite of what the dollar did above. Gold broke through a key resistance level and is slowly drifting back down to test the breakout level to see if it is support. If so then gold should continue higher in the coming days.

Both silver and gold miner stocks are lagging the price of gold. They have yet to break through their key resistance levels. That being said it could happen an day now as they have both been flirting with that level for a couple trading sessions now.

Crude oil continues to hold up strong and is headed straight for its key resistance levels without any real pullback. Chasing price action like this is not something do often because risk reward is not in your favor. I am staying on the sidelines for oil until I see a setup that has more potential and less risk.

The equities market remains in a strong uptrend at this time. I do feel a 1-3 weeks pause/pullback could take place at any time but in the grand scheme of things we could be only half way through this runaway stock market rally as noted in the video.

The equities market is going to gap down this morning which is typical in a bull market. Remember. in an uptrend the stock market tends to gap lower at the open and close higher into the close. And it’s the opposite in a down trend with stocks gapping higher and sell off through the trading session.

Watch Chris Vermeulens detailed video analysis for this week at The Gold and Oil Guy Videos

Chris Vermeulen
The Gold and Oil Guy .Com

Understanding The Basic Language of Option Trading

The peculiar vocabulary and concepts inhabiting an options trader’s thoughts are often the source of confusion to visitors to my world. I have often pondered that learning to understand options is a lot like learning a foreign language. When you arrive in the country whose language you seek to learn, you need a functional vocabulary immediately.

In order to be able to understand my world, I thought it would be helpful to discuss a bit of my language since it is helpful to grasp a few basics. I want to touch on some of the basic concepts necessary to form the basis for a functional language we can use to communicate concepts underlying a rational (hopefully) thought process leading to trade design and management.

In ruminations to come we will return to these fundamental concepts and begin to understand their function in the dynamic world of an options trader. The nuances of their specific structures are beyond the scope of this blog.  We will return to consider these factors in virtually every trade because they re-appear each and every day in my world. For today, just shake their hands and remember their names.

One point not often discussed is the way in which options are priced. The quoted option price is in reality the sum of two separate components. These are referred to as the intrinsic and the extrinsic portions of the premium. I think of these as steak and sizzle respectively.

As I type, AAPL has closed at around $395. The January 390 call has 41 days to expiration and could have been bought for $18.90. Of this sum, $5 represents intrinsic premium and $13.90 represents extrinsic or time premium.

This is an important distinction because it is the extrinsic premium which is subject to time decay and change due to variations in implied volatility. We will get to a discussion of implied volatility in next week’s missive.

The intrinsic premium is subject to change solely due to changes in the price of the underlying security. There is no sizzle in the intrinsic premium; you can buy the option today, exercise it to buy stock, sell the stock, and pocket the $5. Of course, your trading career will not last long with that sort of trade, but my point is that the intrinsic premium has an easily calculable true value.

The situation with the extrinsic premium is quite different. The value changes not only with time to expiration but also with the constantly changing implied volatility. It is for this reason that an option trader must be very careful with this extrinsic component. Depending on the specific option under consideration, extrinsic premium may represent all, a portion, or a trivial amount of the entirety of the option premium.

Another important concept is that of the “moneyness” of an option. An individual option can be classified in one of three categories of “moneyness:”

• At the money
• In the money
• Out of the money

At the money options by definition consist of a single strike price. Both in the money and out of the money strikes usually contain several individual strikes within their groups.

In our example of AAPL, the at the money strike is the 395 strike. The in the money strikes consist of all calls with strike prices below 395 and all puts with strike prices above 395. The out of the money strikes consist of all calls above the 395 strike and all puts below the 395 strike.

Obviously since the price of the underlying defines the category into which an option is classified, the category into which an individual option fits is fluid and changes dynamically with the price of the underlying asset.

The reason for taking the time to discuss in some detail this classification of “moneyness” is that there are important reliable characteristics of each type of option.

At the money options characteristically contain the absolute greatest dollar amount of extrinsic premium. In the money options have the least amount of extrinsic premium. Out of the money options consist entirely of extrinsic premium, and therefore only contain sizzle......no steak can be found there.

Because the functional characteristics of these three categories of options differ, it is a basic strategy to combine options of different “moneyness” to achieve trades with the best probability of success and the highest risk/reward scenarios.

For example, buying an in the money call and selling an at the money call gives birth to a call debit spread, a high probability trade structure for the trader who is bullish in the underlying.

Next week we will cover the stealth concept of option trading, implied volatility. Failure to understand the impact of this variable is the most common cause of beginning options traders’ failure to succeed.

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The Long Term Fundamental Case for Gold

A quick glance at most of the headlines over the weekend and the primary focus seemed to be either calling a near term top in domestic equity indices or a focus on the Greek debt situation. Why is anyone even paying attention to what is going on over there? Until the ISDA declares a default where the underlying Credit Default Swaps (CDS) are triggered, it is all just noise.

The ECB has broken the rule of law by placing itself as the senior creditor ahead of private creditors, the Greek government is trying to pass retroactive legislation to trap private sector creditors holding out of the PSI, and the leader of Greece was not even elected by the people of Greece – how much more manipulation and insanity do we need to monitor?

Similar to the price action since 2008, central banks around the world control everything from financial markets to the ascent of political leaders. These same political leaders help central bankers and planners control policy and decision making at the highest government levels in Europe and around the world. It would seem that the United States should change the motto from “We the People” to “We the Bankers.”

However, there is one particular asset class that even the central bankers have a hard time controlling. While they can impact short term price action through direct currency manipulation initiatives, in the longer-term gold is likely to move in only one direction, higher.

The price action on Tuesday reminded market participants that actions such as the Greek bailout come at a cost. Quantitative easing and/or printing money (depending on what one wishes to call the practice of producing fiat currency out of thin air) has a direct impact on the price of gold.

Many financial pundits argue that gold has no utility, but what they fail to recognize is that gold is the senior currency to all other fiat currencies. Silver is also a form of currency and is senior to all other fiat currencies as well. While one can draw the utility of gold into question, the idea that gold is the senior most currency to all other fiat currencies is not new.

The Constitution of the United States of America, which is over 200 years old, refers to gold and silver as forms of payment. Looking back thousands of years the Romans used gold coins as a form of currency. The idea that gold and silver are currencies is certainly not a grandiose thought or a stretch of historical concept. Trying to depict gold as a worthless asset depends on your view and consideration of fiat currency.

There are those that would argue that the Federal Reserve of the United States is not actively manipulating economic conditions domestically or abroad. For those that view gold as a poor investment or hedge against currency devaluation need to consider the charts illustrated below. The chart below was produced by Thomas Gresham of Gresham’s Law.

Total Asset Growth of the Federal Reserve System – 1915 – 2012

It is rather obvious by looking at this chart that the Federal Reserve has actively sought to enter domestic and foreign financial markets. The surge in balance sheet assets serves to prove how far the Federal Reserve Bank is willing to go to maintain markets which seemingly are only allowed to move higher over time.

This chart is bearish for nearly any form of paper backed assets. The above referenced chart is long term bearish for the Dollar and Treasuries and long term bullish for physical gold and silver. As the Federal Reserve continues to debase the U.S. Dollar in concert with other central banks’ monetary easing programs, gold and silver prices over time are destined to move higher in virtually every form of fiat currency.

During the same time frame that the Federal Reserve has seen its balance sheet grow exponentially, the rapid rise of M2 money supply is staggering. The long term chart of M2 is compared to gold futures in the charts presented below.

M2 Money Stock

Gold Futures Monthly Chart

It is rather obvious what has happened to the price of gold as the M2 money supply has grown. The idea that the Federal Reserve has not already destroyed a significant amount of the purchasing power of the Dollar can easily be refuted by the two charts shown above.

In the short term, gold and silver could suffer from a pullback, but in the intermediate to longer term it is unlikely that we have seen the highs of this bull market for either metal. As long as central banks around the world continue to print money and expand their balance sheets gold and silver will remain in a long term bull market. The daily chart of gold futures is presented below.

Gold Futures Daily Chart

As can be seen above, it is not out of the question that we could see gold pullback to test one of the key moving averages in coming days/weeks. However, I expect the key support area to hold in the event of a sharp selloff. Ultimately, I expect to see a breakout over the resistance zone in the days/weeks ahead. However, I would not be surprised to see gold consolidate or work marginally lower from current prices before breaking out to the upside. Right now the primary threat in this fledgling gold rally is a short term spike higher in the U.S. Dollar. The primary catalyst which could drive a flight to the Dollar involves the sovereign debt situation in Greece and the Eurozone as a whole.

While the short term price action may be bearish, the intermediate to longer term time frames are quite bullish for metals as central banks will continue to race to debase their currencies. Quantitative easing in the U.S. and around the world will become pervasive and gold prices could potentially soar in value. The data from the Federal Reserve Bank itself suggests that they are indeed increasing the money supply. As time has passed, the money supply and gold have seemingly grown in lockstep with one another. Surely inquiring minds do not consider this mutual relationship between gold and the money supply to be purely coincidental.

As further evidence that the Federal Reserve continues to use quantitative easing to manipulate asset prices through direct entry into financial markets, a chart of the velocity of M2 clearly depicts that the velocity of money is declining. I am not an expert regarding macroeconomic data, but if the velocity of money is declining to 1960’s levels would it be a stretch to say that we may be going through a period of stagflation? The chart below illustrates the Velocity of M2 Money Stock courtesy of the St. Louis Federal Reserve Bank.

Velocity of M2 Money Stock

For those unfamiliar with the term velocity of money, it is simply the rate of turnover in the overall money supply. The velocity of M2 is expressed as the number of times that a Dollar is used to purchase final goods or services which are included in the total gross domestic product.

Conclusion

The short term technical picture in gold is a bit suspect due to overhead resistance and recent U.S. Dollar strength. However, the longer term macro factors that impact the value of the U.S. Dollar and precious metals are all telling us the same thing.

As time wears on and central banks do even more to prop up the broader economy and failing financial institutions, it is without question in my mind that gold and silver will both benefit handsomely from these decisions being made by central bankers from around the world.

Ultimately, I am very bullish of gold and silver in the intermediate to longer-term, but in the immediate short term frame gold could consolidate or pullback before breaking out to the upside.

By: Chris Vermeulen – Get Chris' Free Weekly ETF Reports & Analysis 
Co-Author: JW Jones – Get J.W.s Free Weekly Options Reports & Analysis

Did the SP 500 Just Peak at 1356?

This is somewhat of a things that make you go hmmmmmm exercise, but lets examine this 1356 number for a second here. The SP 500 hit 1356 today and put on the brakes and reversed down to 1341 in a possible terminal top move.

1356 actually has fibonacci relationships. If we take the last major rally which was from the Summer 2010 lows:

1010-1370 (May 2011 highs)

360 points

.786 of 360 is 283 points

Take 283, add it to the 1074 October lows…. you got 1356/57

That would mean this last rally so far is .786 of the 2010-11 rally.

Also, 1356/57 is right in my 1352-1376 pivot ranges for a Major 3 top as well

Evidence is mounting for a good sized correction here is my point.

Possible count, though many will argue not valid:

Wave 1- 666 to 1221- 555 points

Wave 2- 1221-1010- 211 points, .38% of 1

Wave 3- 1010-1370 360 points, .61% of 1

Wave 4- 1370-1074- 296 points… 38% of 1-3 (A bit more than 38%)

Wave 5- 1074-1356 .786 of 3

Only rule violation here is Wave 4 would have delved into wave 1, which is a no-no for most E wavers. However, I would argue that 4 often does delve into the wave 1 arena and legitimately, but that is a topic for another article.

Nonetheless… pay attention to the fibonacci relationships… if anything they may be warning of 1356 as an interim high and top with correction starting.  This would either be a 4th wave down with the 5th and final wave up left… or we topped at 1356. A drop below 1337 will confirm a correction at minimum to 1310 and then 1295 ranges.

Just food for thought…...we have been lightening our positions and raising stops at my ATP trading service.  If you’d like to have regular updates on the SP 500, Gold and Silver so you can benefit from major pivots ahead of the crowd, check us out at Market Trend Forecast for a coupon offer.

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