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Let’s look at some indications that the market may be poised to make a large move:

• The FOMC meets today. The expected quarter-point move in the Fed Funds rate target may seem unnecessary in light of last week’s extremely weak GDP figure. A failure to raise the Funds rate would be unexpected. Either one could move the market.

• It’s Greenspan’s last meeting. Everyone hopes that Bernanke will be a great Chairman, but whether you agree with Greenspan’s tactics or not (and I’m sometimes in the “not” category), there’s no question that he’s one of the most brilliant public figures in our lifetime. There is plenty of uneasiness over how Bernanke will handle the stick of dynamite being handed to him. That could move the market.

• State of the Union tonight. What Bush says, particularly in regards to Iran, could move the market.

• Tomorrow is the first day of “the month after” an extremely volatile January. The Big Guys will be in with both feet.

• The indexes are all hovering near the point of the recent range breakout and failure.

• On the Qs, the volume yesterday was the lowest this year, and not only was the bar an nr7, it was an nr19! That looks like an impending move in any technician’s book.

• Google reports earnings this evening. I don’t try to trade particular stocks off of earnings news (anymore), but this one is important because of its effect on the overall market.

The overextended VIX situation I pointed out last week has resolved in classic fashion. I had discussed that some people use the VIX as a primary overbought/oversold indicator, and treat a move of more than 10% from its 10-day SMA as a trade signal.

Here’s a one-month chart of the S&P over a chart of the VIX from yesterday (Friday Jan 27) back:

The VIX peaked at 14.56, 24% above its 10MA on Friday Jan 20. The rubber band was stretched extremely tight, and bounced right back, as seen in the chart above. As the VIX made a return to its 10MA over the ensuing week, the S&P rose about 25 points in unison.

I’ve also labeled on the chart the point where the VIX hit 10% above its 10MA at the open on the first trading day of 2006, and rebounded all the way back down to the moving average as the S&P climbed almost 25 points in one day.

Please be aware– the VIX can return to its moving average without the S&P making a significant rise. However, in order for that to happen, the S&P has to experience an extended sideways movement.

I’ve never used this indicator as a trade signal, but I’ve often referred to it as confirmation of an overbought/oversold condition. When I get time (I average about 4 hrs of free time a week right now), I’ll do some research and post statistics on how reliable this indicator has been in the past. It should be interesting.

What does this mean for the market? The rubber band is right back in the middle of its range, meaning there’s no strong options pressure on the S&P in either direction right now. If Friday Jan 20 was the beginning of a downtrend, the resistance to that downtrend (i.e. rebound buying pressure) has now subsided, and the downtrend can resume. However, there’s also no overt selling pressure evidenced in this indicator right now, so it gives us no clear read one way or the other.

As with many oscillators, this one loses most of its meaning unless it’s at one extreme or the other. But when it is, it can certainly help to confirm whether you’re on the side of probability. What was it Jesse Livermore said? Something along the lines of, “It’s not important whether you’re on the long side or the short side, but that you’re on the winning side!”

From an article in BusinessWeek:

Borrowing a tactic from 12-hour specials at department stores, homebuilder Centex Corp. on Wednesday unveiled a promotion aimed at spurring sales in northern California by offering to cut prices on some models by up to $100,000 for 12 hours next Saturday.

Anyone else see a little red flag here? Perhaps a slight hissing sound, like air escaping from something?

Intel traded 894 million shares in the last five trading days.

Here’s a five-year chart:

Notice that volume bar on the far right. Unprecedented. Is this accumulation on a massive scale? The Big Guys often load up at the ugliest moments, and the only clue is the volume. On the other hand, a look at the daily chart shows each day since the gap has been farther down. Often huge volume associated with accumulation sets a very firm bottom. So far it hasn’t on this one.

Because of that action, I’m inclined to think INTC is being abandoned. If so, that would probably mean months of sideways movement, at the least. If I were looking to get in on this “bargain” with all my life savings and my 401(k), I’d certainly be patient and see if 20 holds. No need to be greedy here.

From Reuters:

The Chicago Board Options Exchange, the largest U.S. options mart, said options volume at the exchange was more than 5.3 million contracts on Friday — the busiest single trading day in its 33-year history.

(Just a followup on my previous post regarding Friday being extraordinary from an options standpoint).

Dow down 213. Nasdaq down 54. S&P down 24.

Not really that big of a move, historically speaking. But among the folks who have spent years trading options, Friday was one of the most memorable days ever.

First, a quick chart of the NDX:

The major indexes all pulled back well into the recent Nov-Jan trading range, and have therefore created a failed breakout. Without an immediate and fierce reversal to the upside, this is an ominous sign. All potential swing trades are off. My picky entry rules kept me from going long last week, and I couldn’t be prouder of them. Scribbling notes to yourself for years sometimes pays off!

The increased volatility should create some amazing day trades, and I’ll be actively watching for those each morning that I have the opportunity. As a matter of fact, check out the VIX (volatility index, used to be based on the S&P 100, now based on the S&P 500):

There’s a legend that some traders make their entire living off of one simple trade: anytime the VIX moves more than 10% away from its 10-day moving average, they go the opposite direction. For instance, if the VIX surges 10% above its 10MA, they go long (the VIX spiking up signifies a selloff). If it drops 10% below its 10MA, they go short. That last one is rare, as it’s hard for a “spike” to equal “decreased volatility.”

The VIX closed at 14.56 Friday (its high for the day, BTW). Its 10MA was 11.71, so that puts it over 24% above its 10MA. According to the above trading strategy, that would indicate a hellaciously strong buy signal.

Imagine jumping in and buying after the uncertainty created by Friday’s drop. Spooky, huh? Welcome to trading. Disciplined trade entry and money management rules are the only way to mitigate that fear and pull the trigger when necessary.

I won’t be attempting the “VIX fade,” as I call it. Not because it’s not legit, but because I haven’t studied it enough to know for sure. It sounds sensible enough.

“One of the Most Memorable Days Ever”

I love watching new traders’ expressions when they ask “What do you think the market’s gonna do” on expiration day (note: options expiration day, for trading purposes, is the third Friday of each month) and I answer “absolutely nothing.” I always chuckle when I hear lines on the idiot box about the “increased volatility due to options expiration” and especially the dreaded “triple witching.” Increased volatility? The indexes get pinned as expiration week progresses, and there are plenty of good trades to be had simply betting that an index will end up in the middle of the last few days’ range. As a matter of fact, I have a rule in my little notebook that says, “Don’t daytrade optionable stocks on Thurs or Fri of expiration week.” That’s because a day trade has much less chance of success on those days as the stock gets reeled back in from whatever move it tries to make.

By around lunchtime on Friday, I was surprised. By 3pm, I was stunned. I couldn’t remember the last time I saw a move like this on expiration day. This was big. Friday night, after getting the kids settled down, I fired up the ‘puter and did some number crunching. I’ve never actually seen any published statistics about expiration day and its supposed “volatility,” but I knew from experience that it’s unusual for expiry day to be anything but dead boring, movement-wise.

Here’s how I did my little impromptu volatility study:

• I downloaded historical data on the Qs (volume numbers more reliable than index volume) back to the beginning of 2000, so I could include the huge lurches the market made in ‘00-’02.

• Wrote an Excel spreadsheet to determine whether a given day was options expiration day (hint: use the DAY and WEEKDAY functions within a couple of nested “ifs”), then compared the volatility of that day’s range to the previous 20 days.

• I made this comparison by taking the average range of the previous 20 days, then the standard deviation in range over the same period, and finally calculating how many standard deviations away from the average expiry day fell.

  Using standard deviations from average factored out the confusion that would be created from trying to simply compare absolute ranges over the years, which would be apples to oranges. An expiry day in 2000 with a range of $4 wasn’t such a big deal if the Qs were $80 and the average range for the previous 20 days was $5/day.

The results of my study of expiration Fridays over the last 73 months are as follows:

• 50 expiration Fridays (68.4%) have been of average volatility (+/- one STD).

• 17 expiration Fridays (23.3%) have been significantly less volatile than average (more than 1 STD below average).

• Only 6 expiration Fridays (8.2%; less than one per year) have been significantly more volatile than average (more than 1 STD above average).

That’s right: fully 92% of expiration Fridays have been of average volatility or less . So much for the “increased volatility of triple witching.” But that’s not the clincher:

• Since January of 2000, only two expiration Fridays have had a range of greater than 3 standard deviations above the prior 20 days’ average:

  1. 4/21/01, which was 5.4 STDs more volatile than average, albeit on lighter than average volume.
  2. You guessed it, 1/20/06, which was 3.7 STDs more volatile, and on significantly increased volume.

No wonder Friday seemed so unusual. One thing is for sure- anyone who happened to be loaded with puts cleaned up like never before (or, almost never). Cheers to them.

What’s this mean for the future? I think that for certain it means we’ll be seeing wider price swings, which is music to the ears of daytraders. It may also mean that we’ve just reached some sort of major inflection point in the market. The new trend will emerge soon enough, and we’ll know for sure.

We’ve gotten our lower highs, but a little lower and faster than expected. Low enough and fast enough to give you that queasy feeling like when the plane you’re in hits an air pocket and drops a couple hundred feet.

This isn’t a perfect setup, but few are, so let’s give it a look:

If we get a nice washout downward spike below 42 on the open tomorrow (Thurs 1/19), then an upward break of the opening range which takes us back above 42, it would be a nice place to get long with a tight stop, which is always a requirement. That’s pretty darned picky. The only other clear trade I’d take here is a gap above today’s high (42.46) with the opening few (5-10min) bars descending down to it. Again, picky. But that’s all I’d take at the moment. With options expiration on Friday, may have to hang around until next week to get a good trade entry.

Why not trade off the inverted hammer that formed today? Rules. I’d be going long above 42.50 with an original stop of just under 42, which would equate to an initial risk, or “R” of probably 55 cents. I like there to be nice clear running room for at least “3 Rs”… in this case that would mean I’d need upside potential of around $1.65, or about $44+ on the Qs. Although that may happen, it’s not what I’d deem “highly probable” from the current chart, so prima facie, ipso facto, I can’t take that trade. Rules is rules.

OTOH, if one of those “picky” setups above happens, I might just be able to sneak in with a nice tight stop and initial “R” of only a quarter. Six bits is an easy-greasy upswing from here, so I’d be duty-bound to take that trade. The rules that say “you gotta take this trade” are the more enjoyable ones.

You may wonder where my picky rules come from. A little spiral notebook filled with wisdom transcribed from hundreds of index cards scribbled over the years while trading. What I did right, what I did wrong, what to do next time. You can never learn as much about your weaknesses from books as you can from yourself, if you just keep very accurate and honest records. Otherwise you just repeat the same emotionally-driven mistakes over and over until you give up in frustration.

Did I just wander off on another tangent? Guess so. It’s late, I’m tired, I jump on the nearest soapbox. Cheers.

An interesting quote from Barron’s noted on the excellent maoxian site:

That is precisely the nature of a bubble. It is concentrated in a relatively narrow sector. The 2000 bubble in the stock market was concentrated in TMT [telecom, media and technology]. There wasn’t a bubble in U.S. Steel or copper stocks or oil. The apologists for the housing-market bubble in the U.S. always point out that it is concentrated in a few markets, but that has always been the case. I don’t buy that if the bubble in California, Florida and Texas deflates, it won’t have an impact on the economy…
Marc Faber