Link: Using the VIX as a Timing Tool

Jul 9, 2007: 7:54 PM CST

Bill Luby at the VIX and More blog posted a three-part resource and his thoughts regarding how to use the Volatility Index as a market timing tool.

Specifically, he discusses how he uses its readings to trade the S&P 500 exchange traded fund SPY.  His concluding thoughts caught my attention:

“…I have increasingly become convinced of its applicability in this area [the VIX’s use as a market timing tool].”

You may also find it useful if you trade options along side ETFs and stocks, as knowing how to analyze the volatility index properly indicates to you how ‘fairly’ options pricing currently exists – essentially when there is greater ‘fear’ in the overall market (as evidenced by rampant put buying), options premiums will rise accordingly.

Some traders use strategies to sell specific options or spreads when fear (volatility) is high because they assume volatility cannot stay elevated, and it should reverse at least to normal or a bit below normal (in which case, it will be advantageous to execute option buying positions).  This also is a method that can be devised to be relatively ‘delta neutral’ if executed properly.

Many people have said it before and I agree:  It is far easier to predict volatility (cycles) than it is to predict market/stock direction.

Either way you feel, it always helps to check on the most recent trend of the VIX to see what the majority of traders are ‘betting’ on a large scale.

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Link: Bridging the Gap Between Cognitive States

Jul 9, 2007: 7:43 PM CST

Have you ever wondered why you have a difficult time applying what you learned in your peaceful room to the actual frenzy of active trading?

Dr. Steenbarger discusses how to take what we study and analyze in quiet times (when the market is closed) and apply that knowledge properly when the market is open and trades are executed in real-time when price is moving constantly, likely creating anxiety.

He summarizes the post in this opening statement:

Behavioral finance researchers observe that our perception, judgment, and decision making in cold cognitive states–those in which we are reasoning analytically–tend to be different than when we’re in hot, emotional states.

Some go as far as saying that we are actually ‘two different people’ in different circumstances (‘cold’ vs. ‘hot’ or possibly ‘study’ vs. ‘active’). Thus, decisions are made differently and we arrive at poorer results that we anticipated, which enhances frustration and confusion if we don’t make the connection between the two states.

Read over the entire short article for tips on how to bridge the gap and look forward to the next post by Dr. Brett on this topic.

He also gives a bonus link to an earlier post entitled Inside the Trader’s Brain: Decision Making and Emotional Arousal that will be of great help to many traders.

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Weekend Update – Bond, Dollar, Sector Rotation

Jul 8, 2007: 9:35 AM CST

Here are your major intermarket analysis charts at a quick, timesaving glance for you:

First, the 10-Year Bond Price is reconfirming its downtrend:

10yr-note-price.png

This is an example of an “Impulse Sell” trade where price makes a large impulse down, retraces back up, finds resistance at a key moving average, and then turns back down hard to continue its trend.

On the exact flipside, Bond Yields are participating in an “Impulse Buy” type scenario where price is confirming its uptrend (which has been a harbinger of bad news for the overall market):

10yr-bond-yield.png

Next, the US Dollar Index experienced a hard sell-off and just stopped short of making new lows.  It could be due for a quick bounce.
us-dollar.png

Finally, according to our 30-day sector rotation model, we are right on schedule near the peak of the cycle, yet the ‘money flow’ predicted by sector rotation theory calls for continuation of our ‘bull-market’ scenario we have now, as investors/big funds are currently in Technology (evidenced by new 6-year highs in the Nasdaq), industrials, materials, and (the big one) energy prices.

sector-rotate-30d.jpg

On the contrary, investors are currently punishing the sectors that do well in bear markets:  Consumer Staples, Healthcare, & Utilities.

Taken together, these evidence a strong case for the current bullish overall market environment.  However, rising bond yields could throw some confusion into the mix should they continue their recent trends.

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AAPL Triangle Breakout

Jul 8, 2007: 9:24 AM CST

This week, AAPL, as a likely direct result of the success of its iPhone sales/hype, broke out of a triangle consolidation chart pattern.

Remember the market rule “Price alternates between expansion and contraction” as supply and demand gets imbalanced following a period of quiet (rangebound) trading.

aapl-triangle.jpg

Price is now extended short-term above the upper bollinger band, and almost all oscillators are showing overbought conditions.

Use this as a study in the pure triangle consolidation pattern.  The buypoint would be slightly (enough) above the apex, or at least outside the converging trendline.  A stop would be placed either on the other side of the trendline (aggressive) or within the trendline following the break (conservative).

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Weekend Index Updates

Jul 7, 2007: 8:57 AM CST

We managed to survive a light volume, holiday week and end the week higher in all major indexes, yet only the Nasdaq is making fresh new highs (although they are merely new 6 year highs).  This tends to be good for the overall market, as it assumes that traders are taking more speculative risk in technology/volatile stocks rather than value or defensive stocks.

dow-july-7.png

dow-weekly-july-7.png

The Dow Jones is about 100 points away from fresh all-time highs, and it wouldn’t take much to push the index to a new high.  There is resistance at 13,700, as we have had six tests of this zone so far.

The weekly chart is working off its formerly overextended conditions, while the daily charts are showing stark consolidation and rangebound trading.

nas-july-7.png

nas-weekly-july-7.png

I am glad to report new price highs and new momentum highs on the Nasdaq index (on the daily charts).  Price is a bit overextended, and odds favor a sell swing coming up to make another higher low to confirm this major uptrend we have been experiencing.  Although the Nasdaq is making new (six-year) highs, it is just over halfway to its all-time highs (around 5,000).

The weekly chart is showing a momentum divergence, but this is absolutely no cause for panic.

The S&P 500 looks very similar (technically) to the Dow Jones, and the Russell 2000 is making a similar pattern of consolidation (no new highs yet, but they’re not far away).

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