If you are a trend trader then past two weeks will most likely turn out to be your most productive ones of the year. As the old adage goes: The trend is your friend until it ends. Of course you cannot help but wonder if the end is in sight, after all we’ve come a long way since early November. So let’s talk about that and add a bit more context which I believe may be of value if you’re still holding long (or are anxiously waiting for an opportunity to go short).
And here it is in all its glory: 13 consecutive higher highs on the Russell 2000. Which again should serve as a reminder to many analysts who continue to rely on normal or even platykurtic distribution (after a long sideways range) and are occasionally steamrolled by leptokurtic distribution.
The advance on the S&P 500 hasn’t been this smooth but I’d be happy to ride a 15% rally in little over two weeks anytime. To answer the question I posed in the intro: No, I do not think this advance is over, probably far from it. However what is most likely over is the easy part of this advance, and that is a consideration which will probably affect your campaign management, or at least it should.
So what do I mean by easy ride? Take a look at the chart above which shows us the daily VIX in grey on top of the SPX in light blue. The second panel below runs a simple ROC against the VIX and on the very bottom you’ll find a light green line which serves as our threshold. The yellow highlights across the entire chart are the ones we are going to focus on, as they show us what I call the ‘easy rides’, and by that I am referring to the initial rally phase of an advance. Quite often these periods are the result of short squeezes which feeds off of accumulated sellers on its way up.
What usually follows the initial fast paced and most brutal ‘easy ride’ is usually one ore several smaller corrections (often due to profit taking), after which the advance grinds higher in a more volatile pattern all the way into the final peak.
In order to better time those final peaks, we are dropping back a little into a weekly chart, which otherwise is pretty similar to the one I posted above. Here our threshold on the lower panel is around the -40 mark which appears to be touched near medium term highs. Remember that this is a weekly chart, therefore we should always wait for a bit more confirmation, i.e. a continued push higher for a week or so, until the odds support that a true high is in place. And that is fine as by then we are most likely seeing some price confirmation patterns as well as more evidence on our momentum charts.
Now despite the fact that the VIX is approaching the 12 mark, the ROC shows us plenty of downside momentum remaining to continue this advance over the coming weeks. A correction over the coming week or two will probably push the VIX by a handle or two, clearing out some weak hands in equities, and thus preparing us for the final leg higher. This scenario would also fit our seasonal expectations, meaning it’s not unusual to see a little shake out preceding the final X-Mas rally.
Although being a comparably simple approach plotting the volatility of implied volatility appears to provide us with valuable clues as to the discrete phases of an ongoing advance. This permits us to better time when to take partial profits, when to re-enter, and how to adjust our campaign management if necessary.