S&P 500 Update

Last week’s update titled “Bears Get Another Shot at Taking Stocks Down” listed four reasons why bears get another shot and two reasons why stocks may continue higher.

This may sound like a contradiction, but it’s actually not. Basically we were looking for a good low-risk opportunity to go short. The higher stocks go, the better the opportunity (as long as you don’t short too early).

The June 1 Profit Radar Report observed some semi-bullish developments and stated that: “Surprises to the up side – to fool the crowded trade – are possible. The market may be tempted to flush out the ‘June pessimists’ first. That’s why we are very careful about initiating our short-trade.”

Barron’s rates the iSPYETF as a “trader with a good track record.” Click here for Barron’s assessment of the Profit Radar Report.

How exactly does being ‘careful about initiating our short-trade’ look like? We use support/resistance levels to our advantage.

The May 24 Profit Radar Report included the following recommendation:

We will go short if the S&P 500 moves above 2,090 (black trend channel) and subsequently drops below 2,084 (May 10 high). Waiting for a break of momentum (drop from 2,090 to 2,084) against resistance increases the odds of a winning trade. The approximate corresponding level for the ProShares S&P 500 Short ETF (SH) is: A drop below 20 followed by a rise above 20.06.”

The hourly chart below shows why 2,084 was important. A drop back below 2,084 would have triggered our sell, but as the green arrows indicate, the S&P 500 never drop that low. It touched the 2,088 – 2,085 zone four times, but bounced every time.

Anticipation of a potential ‘flush the bears spike’ combined with a carefully placed sell trigger kept us in the neutral zone instead of the losing side.

As the S&P 500 continued to rise, we elevated our sell trigger.

The S&P 500 shows a fairly drawn out bearish RSI divergence on the hourly chart, and – unlike the S&P 500 – the Dow Jones has not yet surpassed its April high.

This rally doesn’t have the typical ingredients for a sustained breakout.

Unfortunately there is no particular stopping point. The May 25 Profit Radar Report stated that: “A move to 2,011+/- or 2,034+/- is possible. Due to the market and Elliott Wave Structure at this time, there is no particular ‘make it or break it’ level.”

This trade is not one to be rushed, but unless breadth picks up, odds continue to favor a reversal lower in the not so distant future.

Continued S&P 500 analysis is available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s profile of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Advertisements

VIX Seasonality Suggests Higher Readings

The VIX is back to 2007 levels and actively defying the contrarian implications of extra low VIX readings. Will the VIX drop much further? A look at VIX seasonality provides some clues.

When complacency reigns, investors get wet or at least so goes the saying. The CBOE Volatility Index (VIX) has been trading below 15 for all of 2013, but the only ones getting ‘wet’ are VIX bulls and stock bears.

Still, the VIX is at a 73-month low and eventually there’s some money to be made buying VIX calls or long VIX ETFs. When will that be? VIX seasonality provides some clues.

VIX Seasonality

The first chart provides a visual of VIX seasonality based on data from 1990 – 2012. A devisor has been used to equally weigh each years’ performance.

In an average year, the VIX has seasonal lows in early and late February before spiking to an early March high. This would provide a short window for a seasonal move higher.

The average February to March VIX spike is less than 10%. Obviously, there’s more potential upside in 2013 as the debt and deficit ceiling quandary has the potential to springboard the VIX from its 73-month low.

However, the VIX seasonality chart suggests to eat your ice cream before it melts. In other words, locking in any gains (or carefully managing any gains) before the early-March seasonal high is prudent.

S&P 500 Seasonality

Most of the time there’s an inverse correlation between the VIX and the S&P 500. When the VIX goes down, stocks go up and vice versa.

Does S&P 500 seasonality confirm VIX seasonality? It would in a perfect world, but investing is about odds, not perfection.

The second chart plots overall S&P seasonality (1950 – 2012) and post election year seasonality against VIX seasonality. VIX seasonality (blue line) is inverted for easier comparison of trends.

The dashed red lines mark three trends that line up. One is a mild early-to mid February sell signal (sell signal for stocks, not VIX) followed by a weak late June buy signal and a strong October buy signal.

S&P seasonality also suggests that any February correction may be short-lived.

Seasonality charts capture the general trends of more than six decades and averaging of trends eliminates a lot of ‘seasonal noise’ along with potential setups.

Nevertheless, when seasonality agrees with other indicators (like sentiment, technicals, fundamentals) we get a stronger signal. This could be the case right now.

Long VIX ETPs include the iPath S&P 500 Short-Term Futures ETN (VXX) and VelocityShares Daily 2x VIX Short Term ETN (TVIX).

Short S&P 500 ETFs include the Short S&P 500 ProShares (SH) and UltraShort S&P 500 ProShares (SDS).

How to Spot Low-Risk, High Profit Trades

It’s easy to pick out bygone trading opportunities after the fact – hindsight is 20/20. But this article looks at live low-risk trades and provides a tutorial on how to identify low-risk trades and when to lock in profits.

“Buy the best and forget the rest.” This is the mission statement of the Profit Radar Report. “Buying the best” doesn’t refer to the best stocks but to the best profit opportunities.

The quality of trade setups is more important than the quantity, but how do you spot a quality setup? The next few paragraphs highlight three actual quality opportunities for gold, silver and the S&P 500,

Before we delve into the actual charts, I’d like to define what makes a quality setup.

1) High probability trade: I follow three key market forecasting elements (continuous coverage provided via the Profit Radar Report):

I) Technicals
II) sentiment
III) seasonality.

A high probability (usually equal to a high profit trade) setup only happens when all three indicators point in the same direction. Using this technique I identified the following high probability trades:

Sell: April 2010, May 2011 – Buy: March 2009, October 2011, June 2012.

It’s comparatively rare for my three key indicators to align. But that doesn’t mean there aren’t any quality setups.

2) Low-risk trade: A low-risk setup is a trade with significantly higher profit potential than risk of losses. That’s because the entry point is very close to key support or resistance, which provides a powerful and well-defined stop-loss level.

We haven’t had a high probability set up in nearly half a year, so the quality setups highlighted below are all classified as low-risk trades.

S&P 500

The S&P 500 reached our revised up side target of 1,475 on September 14, the day after the Fed announced QE3. We didn’t go short at 1,475 because the new recovery came come absent of a bearish RSI divergence (the April 2010, May 2011 and May 2012 highs were all market by bearish RSI divergences).

The initial phase of the decline was very choppy and difficult to trade. Key support was at 1,396. The November 7 Profit Radar Report warned that: “A move below 1,394 will be a signal to go short with a stop-loss around 1,405.”

The November 14 Profit Radar Report recommended to: “Place a stop order to close half of our short position at 1,348 to take profits.” The second half was closed out at 1,371.

We closed our positions for a 46 and 27 S&P point profit. At no time was the risk greater than 10 points. The 27 – 46 point gain wasn’t as great as if we entered earlier, but we had a favorable risk/reward ratio and most importantly low-risk profits.

Corresponding ETFs are the Short S&P 500 ProShares (SH), UltraShort S&P 500 ProShares (SDS) or the S&P 500 SPDR (SPY).

Gold

In early October gold was sitting atop quadruple support but sentiment had become frothy. The October 7 Profit Radar Report stated:

“According to the latest Commitments of Traders (COT) report, small speculators are now holding the most net long gold positions in a quarter century. Friday’s action also produced a red candle high. Both developments are generally bearish. However, as mentioned in Wednesday’s PRR, gold prices remain above quadruple support (2 trend lines, 20-day SMA, and 61.8% Fibonacci). As long as prices remain above support we’ll give this rally the benefit of the doubt. A move/close below 1,765 will be a signal to go short for aggressive investors with a stop-loss at 1,775” (later raised to 1,777).

When should we take profits? The October 25 Profit Radar Report said this: “Gold dropped to support at 1,700 today. We are getting to a point where it becomes tempting to lock in a 65-point gain. Since gold hasn’t seen a daily bullish RSI divergence yet either, we’ll hold our short position. We’ll sell half of our holdings at 1,680.

We sold half of the gold position at 1,675 in early November and the second half at 1,725 a few days later and captured a 5% and 2.5% profit. Corresponding ETF trades were a) short the SPDR Gold Shares (GLD) or b) buy the UltraShort Gold ProShares ETF (GLL).

Silver

Silver broke above trend line support on July 25 at 27.30. This was a buy signal. Our stop-loss was at no time more than 2% below the entry price (initially red, than green trend line).

In hindsight we could have held on to the position as long as the sharply ascending green trend line remained in tact, but hindsight is 20/20.

We closed the position around 30 and 32 for a 10% and 16% gain in the iShares Silver Trust (SLV).

Future low-risk and high probability trade signals are available via the Profit Radar Report. Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Disappointing Earnings May Be An Opportunity for ETF Investors, But …

The earnings season is in full swing. Most heavy hitters are slated to report earnings this week or next. Rather than overanalyzing the effect of one or two companies, this article looks at the opportunity and risk presented by the long-term earnings picture.

Even before this year’s earnings ritual started, a number of companies spoiled the third quarter earnings season. Intel, Caterpillar, FedEx and many others warned that estimates were too high.

Bloomberg reported that earnings pessimism among U.S. chief execs is the highest since the 2008 meltdown and the Wall Street Journal warns of an “earnings pothole.”

The S&P 500 has rallied as much as 37% since the October 2011 low and the stock rally has become extended. Could a bad earnings season push stocks off the edge?

De-focus On Earnings

Earnings are just one of many forces that drive stocks, in fact I consider them secondary and to some extent a contrarian indicator. Record high Q1 2010, Q1 2011, and Q1 2012 earnings were followed by dismal short-term stock performance so disappointing Q3 2012 earnings don’t automatically translate into falling stock prices.

Seasonality is favorable for most of the remaining year and key technical support for the S&P 500, Dow Jones and even the Nasdaq-100 is holding up. Let’s take a closer look at the S&P 500’s technical picture.

Since June the S&P has been climbing higher within the black parallel trend channel. The S&P’s rally stopped at 1,474.51 on September 14, which was exactly when the upper parallel channel line converged with a decade old resistance line.

Ironically that was just one day after Bernanke promised unlimited QE3. They say don’t fight the Fed, but in this instance the Fed lost to technical resistance. The decline from the September 14 high helped digest overly optimistic sentiment and put the trading odds in favor of going long.

The October 7, Profit Radar Report cautioned of lower prices, but viewed any decline as an opportunity to go long: “A digestive period that draws the S&P to 1,450 and perhaps towards 1,420 seems likely. The highest probability trade is a buy signal triggered by a move below the lower black channel line (around 1,420), followed by a move back above.”

Using trend lines to identify buying or selling opportunities worked like a charm in 2010 and 2011 (trend line breaks were a major contributor to short recommendations in April 2010 and May 2011), but starting in 2012 the S&P delivered a number a fake trend line breaks.

That’s why the above recommendation was to wait for a break below trend line support followed by a move back above before buying. The strategy worked. From here we simply elevate the stop-loss to guarantee a winning trade. We will go short only if the next important support is broken.

Long-term Earnings Message

Even as the economy continues to deteriorate, corporate earnings have slowly crept to new all-time highs. That’s right, all-time record highs.

The chart below plots operating earnings for S&P 500 companies (as reported by Standard & Poor’s) against the S&P 500 Index. Corporate earnings are the epitome of a mean reverting indicator and as predictable as a boomerang.

Every time corporate earnings get too high they reverse and the boomerang hits stocks. Nobody knows how high is too high. Right now, too many are expecting the boomerang to hit so it may take a bit longer, but we’re getting there.

Summary

Over the short-term (possibly into Q1 or Q2 2013) stocks may continue to rally (despite disappointing Q3 2012 earnings), but the long-term implications of record high earnings are deeply bearish for stocks.

The short-term opportunity for investors is to buy the SPDR S&P 500 ETF (SPY) on pullbacks (as long as they remain above key support). I don’t have a specific up side price target, but we’ll take profits when we see bearish technical divergences.

Concurrently we’ll be watching for a market top. Unfortunately, market tops aren’t a one-time event, it’s a process. Like knocking over a Coke machine, you have to rock it back and forth a few times before it falls over.

We’ll be looking at ETFs like the Short S&P 500 ProShares (SH) and UltraShort S&P 500 ProShares (SDS) once we see bearish divergences confirmed by sentiment and seasonality.

The Profit Radar Report will identify low-risk and high probability buying opportunities when they present themselves.

Week Ahead for the S&P 500 – QE3 vs. Worst Week of the Year

Last Friday was triple witching and the week after triple witching is notoriously bearish. How bearish? The S&P 500 Index has closed down 22 out of 26 weeks since 1990 (82%) with average maximum losses about 5x as high as average maximum gains.

Historically short sellers of stocks have an 82% chance of making money this week. However, the S&P 500 Index failed to registered a bearish price/RSI divergence at its September 14 recover high.

All recent highs that were followed by a decline of around 10% or more were foreshadowed by a bearish RSI divergence (I use a unique RSI setting to spot divergences – see chart below). So even a bearish outcome this week would likely be followed by higher prices later on.

The purpose of the Profit Radar Report is to identify high probability trading opportunities. With the conflict between bullish technicals and bearish seasonality, there obviously is no high probability set up right now.

One of two things will have to happen to create a better set up:

1)   Prices decline to trend line support to present a possible buying opportunity.

2)   Prices spike quickly to a new high accompanied by a bearish price/RSI divergence to set up a possible shorting opportunity.

Non-leveraged ETFs that can be used to trade the above set up are the S&P 500 SPDR (SPY) and Short S&P 500 ProShares (SH).  Leveraged options include the Ultra S&P 500 ProShares (SSO) and UltraShort S&P 500 ProShares (SDS).

An early tip off to the next developing set up may be a developing triangle. A break out above or below triangle support/resistance should give us a measured target, which may quite possibly set up an even better opportunity than the actual triangle.

Continuous updates and trading opportunities are provided via the Profit Radar Report.