Can the S&P 500 Suffer Another ‘Air Pocket Decline?’

The last S&P 500 update highlighted the bearish implications of trend line resistance and the ominous VIX wedge.

I reiterated the importance of this trend line in the July 28 Profit Radar Report when stating that: “We are looking at many indicators, but the purple trend line – boring as it may seem – is probably more helpful than other gauges at this point.”

The S&P 500 fell over 200 points after tagging purple trend line resistance (see ‘before and after’ charts below).

Obviously, the purple trend line worked, but will the S&P 500 tumble another few hundred points as implied by the expanding triangle pattern (wave E shown on left)?

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

Here are a few other facts and indicators to help gauge the odds:

New Lows

On Monday, 249 NYSE-traded stocks fell to new 52-week lows. This is the highest reading of 2019. In fact, it’s very unusual for such high 52-week low numbers to occur so soon after the S&P 500 was at an all-time high. The blue lines in the chart below show other times when 52-week lows spiked above 240 when the S&P was within 10 trading days of a 52-week high. It wasn’t a good sign for stocks.

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Technicals

The S&P 500 is back above trend line resistance (now again support, tomorrow around 2,905). As long as trade remains above this green trend line, the rally can continue higher.

Next resistance is at 2,950 – 2,985.

Island Reversals

The term island reversal is often associated with tops but can also mark bottoms. It simple donates a number of candles at a price extreme separated by two gaps.

As outlined by the blue oval, the S&P 500 just staged an island reversal to the up side.

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As indicated by the blue lines below, similar island reversals occurred in August 2,015, December 2015, February 2016 and June 2016. The short-term performance was mixed, but long-term performance was positive.

Breadth

Monday’s Profit Radar Report stated that: “Today’s drop saw 87.87% of all stocks declining. This tends to be indicative of at least short-term lows. A bounce is likely.

The developing bounce delivered an 83.45% up day (83.45% of NYSE-traded stocks advanced) Thursday. The green lines in the chart below show that this has been positive 3 of the last 5 times it happened.

Summary

Purple trend line resistance has been validated by the S&Ps 200-point drop. It’s rare for indicators to foretell are massive drop, but the evidence allows for a continuous decline.

The S&P 500 will have to stay below resistance (2,985) and fall to new lows to start validating the bearish implications of the expanding triangle pattern discussed here.

Continued updates, projections, buy/sell recommendations are 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 evaluation 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, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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

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S&P 500 at ‘Make it or Break it’ Level

The S&P 500 has reached a seemingly important ‘make it or brake it’ zone. Here’s why:

For the last couple of weeks, I’ve been following two scenarios:

1) Washout decline with target of 2,500 – 2,500 (purple arrow, chart below)
2) Accelerating wave 3 lower (yellow arrow, chart below)

The two scenarios were first introduced via the December 9 Profit Radar Report, which stated that:

A brief drop below 2,618 (with next support at 2,607, 2,550 and perhaps as low as 2,500) followed by a quick recovery would preserve the bullish divergences and suggest sellers got ‘washed out’ and a year-end rally is underway. Persistent trade below 2,618 and 2,607 means we need to allow for more weakness.”

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

Both scenario had the same outcome, mentioned in the December 12 Profit Radar Report: “We assume with a high degree of certainty that this rally will ultimately re-lapse to new lows. The question is not if but when.”

Although I amended the ideal down side target for scenario #1 to 2,478 (December 16 Profit Radar Report), the decline has gone a bit further than I initially thought.

Nevertheless, up until now, both scenarios pointed in the same direction. That’s no longer the case.

A (sustained) break below the blue trend channel and Fibonacci support (both around 2,478) will tilt the odds significantly towards scenario #2, which could see the S&P drop another 100 – 300 points.

Assessing the Odds

Based on Elliott Wave Theory, the odds are 50/50.

Statistically, the odds of a breakdown are less than 15%. How so?

The red graph below shows the average path of the past 10 bear markets (as defined by Ned Davis Research). On average, the S&P does not fall more than 16% during the average bear market (this average includes the 2000 and 2008 bear markets).

Today’s performance was unique and remarkable in many ways:

  • S&P 500 closed down 1.54%, but VIX was unchanged
    Since 1992, VIX was unchanged or lower when the S&P was down more than 1% only 32 other times. Over the next month, the S&P rose 81% of the time, on average 2.4%
  • S&P 500 turned a >1.5% gain into a >1.5% loss
    Since 1982, the S&P turned a >1.5% gain into a >1.5% loss 7 other times. 1 week, and 1 month later it was up 86% of the time.
  • S&P 500 lost > 1.5% on an FOMC day
    Since 1996, the S&P lost >1.5% on a FOMC day 5 other times. 1 week later, it was up 60% of the time, 1 month later it was up 80% of the time (datasource: SentimenTrader).

Summary

The S&P 500 just suffered the worst start to a December since 1931. Although statistical odds favor a bounce from here, Elliott Wave Theory cautions that a break below 2,478 can unleash another wave of selling.

Continued updates are 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 evaluation 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, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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

S&P 500: Does Low Fear Portend High Risk?

Below is a free excerpt of the December 9, Profit Radar Report, which takes a detailed look at various sentiment, liquidity, breadth and moment indicators to gauge the down side risk. Since this update is published out of context with all the other updates, an additional “Summary” section is provided at the end of the December 9 Profit Radar Report to provide bigger picture context.

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

                                       * * * * * December 9, 2018 Profit Radar Report * * * * *

The S&P 500 closed at 2,633.08 on Friday. That’s only 1.99 points higher than the November 23 low. If the S&P would have closed at a new low, it would have been interesting to see if there are any bullish divergences.

Well, futures are down 20+ points in Sunday’s trading, so let’s just pretend the S&P closed at new lows, and look for potential divergences anyway. The blue box highlights the price action since the September high.

  • RSI-35 did not confirm the ‘new low’ (RSI-2 is near over-sold)
  • The cumulative NY Composite a/d lines did not confirm
  • The NY Composite a/d ratio did not confirm
  • The percentage of stocks below their 50-day SMA did not confirm

How about different sentiment gauges?

  • The VIX is below its October extreme
  • The VIX/VIX3M ratio is below its October extreme
  • The CBOE equity put/call ratio is at the same level
  • Contango is above its October extreme
  • The SKEW carved out a new low
  • The CBOE equity put/call ratio (5-day SMA) is below its November extreme
  • NAAIM equity exposure is about even, but above its November extreme
  • Bullish Advisors polled by II are less bearish than last week
  • Bullish Investors polled by AAII are less bearish than last week

All the above indicators show that there is little panic, certainly less panic than in October or November. This could be viewed as either 1) a bullish divergence or 2) there is enough room for the market to fall further.

Based on Elliott Wave Theory, the S&P 500 could be 1) nearing the exhaustion point of this down leg, or 2) be in a strong and sustained wave 3 lower (S&P could still rally towards or into 2,700s before next down move). The summary section below discusses which scenario is more likely.

Another attention grabber was last week’s ‘death cross,’ where the 50-day SMA fell below the 200-day SMA.

The last time death cross that received a lot of attention was in May 2016, when the 50-week SMA fell below the 100-week SMA. This was supposed to be an ‘irrefutable sell signal,’ but ultimately turned out to be one of the best buying opportunities ever.

At best, SMA crossovers have a spotty track record, and we don’t base our anlysis on such lagging indicators. For those interested, the arrows in the weekly chart below mark all bearish and bullish 200/50-day SMA crosses over the past 20 years (weekly chart shown to capture longer-term history of signals).

Shown below are various support levels that may help navigate the coming weeks, and answer the question posed above: What’ next? Sustained move lower, or quick wash out decline followed by snap-back rally?

  • 2,618: Black trend channel
  • 2,607: Wave C = 61.8% wave A
  • 2,550: Wave C = 78.6% wave A
  • 2,500: Fibonacci support going back to 2011
  • 2,478: Wave C = 100% wave A
  • 2,385: Trend line support going back to 1998
  • 2,280: Trend channel support going back to 2009

The Russell 2000 IWM is in the general green support range, with trend channel support at 143.25 and 141.30. A bounce from 143.25 – 141.30 seems likely, but sustained trade below the lower trend channel would unlock lower targets.

The Nasdaq-100 QQQ has a general range of support at 161 – 157. A break below, would likely lead to a retest of the February/March lows at 154-150.

Summary: The above analysis was based on Friday’s closing price. The S&P 500 futures chart below includes Sunday’s 20+ point drop. Trade is right around black trend channel support. Anytime prices reaches support, odds of a bounce increase.

Based on the Elliott Wave Theory structure, we are trying to figure out whether we are nearing the end of this down leg (with a potential wash out decline), or if trade will accelerate lower (as a wave 3 would).

A brief drop (1-3 days) below 2,618 (with next support at 2,607, 2,550 and perhaps as low as 2,500) followed by a quick recovery would preserve the bullish divergences and suggest sellers got ‘washed out’ and a year-end rally is underway.

Persistent trade below 2,618 and 2,607 means we need to allow for more weakness.

We will take a stab at going long (only with a small amount as this correction may carve out lower lows eventually) if the S&P 500 drops below 2,607 and subsequently rallies above 2,620 (stop-loss to be set at that day’s low). The SPY buy level is thus linked to the S&P 500 (approximate corresponding SPY levels: buy on drop below 261 followed by move above 262.10 with stop-loss at day’s low).

The very first graph of today’s update (S&P 500 in 2011 – blue box) illustrates what a wash out decline may look like.

                                        * * * * * December 9, 2018 Profit Radar Report * * * * *

SUMMARY: The lack of fear, expressed by various ‘bullish divergences,’ is likely to result in a short-term bounce. Back in September, we expected a correction toward 2,400, and that seems still likely (longer-ter S&P 500 outlook available here). A drop toward 2,400 (or at least below 2,500), would probably trigger the kind of ‘panic readings’ commensurate with a more significant bottom.

Continued updates are 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 evaluation 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, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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

US Stocks: 5 Intriguing Charts, 1 Conclusion

Here is a look at the 5 (in my humble opinion) most intriguing and important charts right now. As you will notice, not all charts point in the same direction. Nevertheless, I will conclude with a weight of evidence-based conclusion.

1) S&P 500 Tug of War

The July 15 Profit Radar Report introduced subscribers to a massively bullish S&P 500 chart pattern with an up side target of 3,000+.

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

The chart insert shows price since July 15. Thus far, triangle support has held, the pattern has not been invalidated, but also not confirmed.

Short-term, as brought out by the August 8 Profit Radar Report, sellers have a window of opportunity due to triple resistance around 2,860.

2) Nasdaq Resistance

The Nasdaq-100 QQQ is up against double resistance comprised of the red trend line and a Fibonacci projection level going back to its 2002 low. As long as resistance holds, bears have a window of opportunity to take QQQ lower.

3) Bear’s Best Friend

All major indexes (S&P 500, Dow Jones, Nasdaq, Russell 2000) have been dancing to the beat of their own drum.

For a broader assessment of US stock’s health, some look at the NY Composite (NYC), which includes some 2000 stocks.

The NYC thus far only retraced 61.8% of the decline from the January high. 61.8 is a Fibonacci number, in fact, it is the ideal retracement of a counter trend rally, a dead cat bounce. That’s what makes the NYC “bear’s best friend” right now.

A look under the hood however, reveals two important facts:

  • More stocks have been advancing than declining (blue graph)
  • The ratio of advancing stocks has slowed significantly (gray graph)

Based on the NYC advance/decline line and ratio, the most likely outcome is short-term weakness followed by longer-term strength.

4) VIX

The August 1 Profit Radar Report published the chart below, which plots the VIX against hedgers’ (smart money) exposure and seasonality. Based on those factors, a spike to 17 (red trend line) seemed likely.

This week, the VIX spiked from 10.17 to 15.02, a 47% move. Higher readings are still possible.

5) Doom-and-Gloom Hurray

Investors loved doom-and-gloom stories a couple weeks ago. I took a screenshot of most popular MarketWatch articles on July 31. The top two were:

  • Prepare for the biggest stock-market selloff in months, Morgan Stanley warns
  • This ‘prophet of doom’ predicts stock market will plunge more than 50%

Admittedly that’s anecdotal evidence, but heavily bearish investors tend to get burnt first. The early August rally did just that.

Conclusion

If you want to be bullish, there’s plenty of data to support your view.

If you want to be bearish, there’s plenty of data to support your view, too.

Looking at the data objectively, my conclusion (based on the weight of evidence) is that short-term weakness will provide at least one more buying opportunity.

Weakness may not materialize if the S&P 500, Nasdaq, NY Composite move above their respective resistance levels.

Support levels, up side targets and continuous updates are available in the Profit Radar Report.

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s 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, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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

What’s Next: New Highs or Lows?

Even just a quick glance at the S&P 500 chart reveals a tug-of-war between bulls and bears, buyers and sellers. Although there’ve been many – at time violent – swings, there’s been no net progress.

What will we see first, new highs or new lows? Here’s a look at various pieces of market research:

Long-term:

Hypervolatility – April 11, 2018 Profit Radar Report:

What a contrast: In 2017, the S&P 500 swung more than 1% on only 10 days. That’s measured from daily high to low, not open to close. In 2018, the S&P 500 had already 41 daily swings of more than 1%.

Below is a closer look at actual volatility, not the VIX. The first chart plots the S&P 500 against the daily percentage change measured from high to low (gray graph) along with a 20-day SMA of the daily percentage change (blue graph).

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Business Daily says: “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

In February, the daily swing range was nearly as big as in September 2015 and January 2016, which is when stocks bottomed. Back then, volatility came and went quickly (like the shape of a ‘V’). This time around, volatility is lingering longer.

The second chart provides a long-term perspective, which includes the 1974, 1987, 2002, 2007, and 2011 market lows. Back then, daily swings (20-day SMA) peaked around 4%, twice the current average of around 2%.

Based on positive liquidity (NYC a/d line) and the parallels to 2011, it’s unlikely that the daily swing range will double from 2% to 4% as stocks melt lower.

The main takeaway is that volatility extremes are usually seen towards market lows.”

Elliott Wave Theory (EWT) – February 11, 2018 Profit Radar Report:

For well over a year stocks have almost exclusively gone up, slow but steady. For the past two weeks, stocks have gone down quickly.

What’s next? The temptation (and trap) is to think two dimensional – up or down – since that’s most of what we’ve experienced lately. However, stocks could also go sideways for a period of time.

The weekly S&P 500 chart provides some long-term perspective. 1 – 2 – 3 is how we label the rally from the February 2016 low. Wave 3 (wave 5 of wave 3 to be exact) extended much higher than normal.

Based on EWT, wave 3 is followed by wave 4, which is where we are currently at. Waves 4 are generally choppy, range-bound, long-winded, unpredictable corrections that retrace ideally 38.2% of the preceding wave 3. The 38.2% Fibonacci retracement level is at 2,536 (reached on Friday).

In terms of price, wave 4 has already reached its down side target. In terms of time, wave 4 would be unusually short.”

Liquidity – April 18, 2018 Profit Radar Report:

On the bullish side of the ledger, we find that the NY Composite advance/decline line (and NYC OCO a/d line) made new all time highs. This follows the bullish divergence noted in the April 4 PRR.

Long-term summary:The weight of evidence suggests that this correction will be temporary and followed by new all-time highs. But how much longer will this correction last and how low can it go?

Short/Mid-term:

Breadth – May 2, 2018 Profit Radar Report:

As early as February 11, the Profit Radar Report expected a frustrating, drawn out correction like in 2011. There are many parallels between the 2011 and 2018 correction, but here is one difference:

In 2011, there were multiple strong up days (where more than 80% or 90% of stocks advanced – green lines), and strong down days (where more than 90% of stocks declined – red lines).

The strong down days exhausted sellers, and the strong up days indicated internal strength not yet reflected in price.

The 2018 correction is much different. There’ve been only two days that come close to be considered a 90% down day, and only one 80% up day.

To end this sideways range, it appears that either more 90% down days or 80%-90% up days (like in October 2011, see green arrow) are needed. Ideally we’d like to see both, first a bout of strong down days followed by strong up days.”

Seasonality, cycles, pattern – May 6, 9, 2018 Profit Radar Report:

Based on mid-term seasonality (blue graph, chart below), the S&P has a tendency to bottom between late June and late September. Cycles are fairly similar to seasonality at this time.

Year-to-date the S&P is down 0.38%. Since 1950, the S&P 500 showed at loss of 1% (but no more than 5% below 200-day SMA) after the first 4 months 17 other times.. 6 of those 17 instances occurred in mid-term election years (like 2018). The average full-year performance is shown below (average bottom: trading day #193).”

Summary:

The April 2 Profit Radar Report (when the S&P 500 closed at 2,582) stated that: “The S&P 500 has met the minimum criteria to consider this correction complete. There is, however, a difference between minimum and ideal.”

The S&P continues to be stuck in the ‘twilight zone between minimum and ideal.’

Short-term, the May 13 Profit Radar Report probably defined it best: “The S&P 500 broke above triangle resistance. Although we view this breakout with a fair amount of skepticism, we need to allow for higher prices while trade remains above 2,700. Due to the overbought condition, it is unlikely for the S&P to move above 2,750 early this week.”

Continued updates will be 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.

S&P 500 Update: Is This Rally Leg Over?

The September 5, 2016 Profit Radar Report published the chart below along with the following commentary:

The chart below shows the long-term up side target purely based on projected symmetry. Based on the 1997 – 2013 trading range, the measured up side target is S&P 2,330 – 2,485, which is in the general vicinity of the 2,290 – 2,342 Fibonacci levels mentioned in the 2016 S&P 500 Forecast. Higher targets are possible, but we’ll reassess once we get there.”

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Bussines Daily says “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

The second chart shows the trading activity over the past year along with short-term bars and trend lines we used to narrow down the up side target (the latest up side target was 2,494).

Short-term X-Ray

A special August 7 Profit Radar Report update featured this potent warning:

The S&P 500 ETF (SPY) closed at a new all-time high at the lowest volume of the year. For the first time in a while, there is a bearish divergence between the S&P 500 and the NY Composite a/d lines. The ideal scenario (and tempting setup to go short) would be a spike to 2,495+ followed by an intraday reversal.”

This is almost exactly what happened. The S&P 500 spiked as high as 2,490.87 before falling 52 points.

However, this drop quickly caused an oversold condition.

A special August 10 Profit Radar Report update featured this chart and stated that:

The CBOE equity putt call ratio (last chart) spiked to the highest reading (0.88) since April. The VIX is overbought. The VIX/VXV ratio jumped and contango fell. Both are near levels that have been seen at VIX highs. Stocks are oversold and ready to bounce. Based on the wave structure, we anticipate this bounce to be brief (2-6 days) and stay below the prior all-time highs (although the extent of the oversold condition would allow for a stronger bounce).”

Conclusion

The August 28, 2016 Profit Radar Report featured a bullish Elliott Wave Theory count with a projected up side target around S&P 2,500 (more details here: S&P 500 Update – Expect the Abnormal).

One of the images featured was a conceptual “We are here” chart (shown below). The green dots mark where we were in August 2016 (along with probability scores).

The red circles highlight where we are at today. The upcoming correction should be a choppy and frustrating wave 4 decline to be followed by another rally to new all-time highs. It then remains to be seen whether that high will be a major top or not.

Since the S&P did not quite reach our up side target, there is an alternate interpretation, which allows for continued gains almost immediately. However, that remains only an alternate unless the market tells us otherwise.

Continued analysis, with down side targets and buy/sell signals are provided 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.

 

This ETF Flaw Caused Subscribers a 30% Loss, But we Fought Back

I am about to share the worst trade of my carrier with you. It cost me a fair amount of sleep (and probably cost me a number of subscribers, who must have thought Simon is quite the moron).

Here is the sad tale of a good trade hijacked by an ETF flaw (fortunately there’s a happy ending).

The Setup

Earlier this year, in mid-January, we saw a number of VIX extremes, such as highly elevated SKEW readings (SKEW measures ‘black swan’ risk), near-record SKEW/VIX ratio readings and the highest ever long exposure of commercial VIX traders (smart money). The charts below, published by the Proift Radar Report in January, illustrate the extremes.

Barron’s rates iSPYETF as “trader with a good track record” and Investor’s Bussines Daily says “When Simon says, the market listens.” Find out why Barron’s and IBD endorse Simon Maierhofer’s Profit Radar Report.

Statistically, those conditions led to an average VIX spike of 22% over the next month every time (even a week later the VIX was higher 85% of the time).

The biggest problem (which we were well aware of) was the lack of a suitable trading vehicle for long VIX exposure. Yes, there is VXX, but it suffers from contango (we have often successfully shorted the VIX via XIV, which puts contango in our favor, more about XIV below).

What is Contango?

Below is a brief explanation of contango (taken from an August 2014 report):

The VIX quoted in-day-to-day life is the CBOE Volatility Index (VIX) spot price (today’s VIX price). However, the futures used to create ETPs like the iPath S&P 500 Short-Term VIX Futures ETN (VXX) are based on the future VIX price, which is almost always more expensive than the spot price. Over time the more expensive VIX futures decline in value, eventually converging with the spot price at expiration.

The chart below compares the current spot price with various futures prices. The difference between the spot price (12.20) and the September futures (13.45) is 9.84%. In other words, it will take a 9.84% move in the VIX to neutralize the time decay between the spot and September futures price.

As time goes by, ETF providers are forced to continuously replace expiring futures with new (more expensive) futures (this process is called ‘rolling over’). The further away the futures expiration date, the bigger the time premium. This time premium and resulting value decay is called contango.

Contango vs the Setup

Despite contango, the VIX buy signal seemed strong enough to deliver a net gain (a 20% short-term VIX spike tends to translate into a 5-7% VXX gain). We were looking for a short-term VIX spike, before a multi-week S&P 500 rally.

On January 23, we pulled the trigger and bought a very small amount of VXX at 20.60. A week later, the VIX traded higher, and a month later, the VIX traded higher. The VIX even spiked 22% (as expected) a number of times, but VXX contango persistently eroded VXX.

VXX by-passed the short-term VIX spike, and then, as anticipated, the stock market continued higher (which kept the VIX depressed). Nevertheless, we expected a period of choppy trading (volatility) to start in February/March.

On March 1, the S&P 500 topped, and has basically been range bound since.

On March 23, it was obvious that the VIX would fall again before the next window for a S&P 500 correction arrived. We bought XIV to hedge VXX, which turned out to be a great move.

The Next Window

The window to unwind this unfortunate VIX trade finally arrived this week. The May 14 Profit Radar Report stated that: “We are still looking to sell XIV and double up on VXX at S&P 2,407. Aggressive traders may elect to short the S&P around 2,410.”

Unfortunately there was another blow. The S&P 500 missed our trigger level for XIV and VXX (2,407) by one point (on Tuesday, March 16). The S&P gapped lower the next morning (by 17 points), robbing us of the best opportunity to unwind this trade.

We took the second-best opportunity. The March 17 intraday Profit Radar Report recommended to sell XIV at 77.40, and double up on VXX at 14.45. We closed XIV for a profit of 12.17% and bought VXX at 14.45.

The next morning (Thursday, March 18) we closed our entire VXX trade at 15.97. The VXX portion bought on January 23 accrued a 22.47% loss, the VXX portion bought on May 17 ended with a 10.51% gain. The 11.96% loss was offset by the 12.17% XIV gain.

At the end, we closed this unfortunate trade combo with a tiny 0.21% gain.

Lessons Learned

Patience and impeccable timing (at the end) rescued this trade, but in hindsight, the best worst trade is one not taken.

Contango needs to be respected. In the past, we traded XIV six times (XIV benefits from contango). All six XIV trades were profitable (12.17%, 14.46%, 13.33%, 7.57%, 15.70%, 4.49%). It’s better to focus on XIV (falling VIX) than VXX (rising VIX), especially in a bull market.

Although we knew that the VIX would fall mid-term, we bet on a short-term rise. It’s not smart to bet against the larger trend.

With the VXX trade closed at a miniscule profit, we keep our streak of no losing trade (since June 2015) alive.

The Profit Radar Report provides about 20 specific trade setups per year.

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.

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