Well hello friends! Ready for a big trading week ahead? Let's dive into the charts together and identify some key areas of interest.
Starting with the most basic of analysis, let's look at ES_F on a daily timeframe with the important Moving Averages plotted. As you can see from the chart above, the S&P500 is currently hanging out in a familiar old battleground that buyer's were not able to hold last time we were here. Will they be victorious this time, or is the "bear market rally" finally over?
Unfortunately I don't have a crystal ball, but I do have the ability to make data-driven decisions to manage my portfolio. During this week's Market Prep, I'd like to focus on two areas of potential confluence for initiating trades, as well as a topic I NEVER speak about: hedging.
Those of you that have been following my work for a while can attest to the fact that I really don't talk about the concept of hedging portfolio risk very often. Why? Because I think it's a grossly overused concept by FinTwit that leads to the magical phenomenon of trading guru's (or "Furu's") never being wrong...they always seem to be "hedged" at the perfect time. I personally think +90% of it is complete garbage, so I've made it a point to be very transparent with you all about when I am in fact hedging my equity exposure.
I think there's good reason to hedge this week, let me show you with data (instead of hindsight analysis) why I am feeling that way.
First things first: We have more critical inflation data coming out this week (CPI and PPI), which is undoubtedly the leading narrative in overall market activity right now. From a trading perspective, this means Wednesday and Thursday pose event-driven risk.
Secondly, volatility is "fairly priced" right now compared to the recent past:
While this makes hedging via Put Spreads or owning volatility a "better deal," it's not the basis of my thesis. Let me show you what I'm looking at:
WARNING: The daily SPX/VVIX Correlation Coefficient chart above will make any quant spit their oatmilk latte out of their nose with laughter. It's not quite as bad as doing TA on the VIX...but it's pretty close.
I've had many debates in the past with other traders about the validity of using VVIX (Volatility of the VIX) vs SPX in a correlation analysis. There are valid statistical reason why this is a "no no," nevertheless I'd by lying if I said I didn't look at it when it hits extremes. Now, we are NOT currently at an extreme reading, but we're "sprouting." When I was a boy, I played a lot of Euchre with my grandmother and the traditional way of keeping score in that card game involved using a pair of 5s, uncovering another suit on the cards every time you scored another point. When my grandmother could "feel" another point coming on, she would prematurely start to uncover another suit symbol and announce that she's "sprouting." Based on the chart above, the correlation coefficient (10) between VVIX and SPX is barely turning red. A visual inspection of the color-coded candlesticks on the chart above shows that it's not a terrible idea to be holding a hedge when we flip red...especially with event-driven risk on the horizon. It's entirely possible I am a week early, but I'll definitely be keeping an eye on this sprouting correlation, even if it makes the quants snortle.
In terms of directional bias this week, we have a well-defined Balance Zone that should make this really easy for us:
To keep this as simple as possible, I'll be favoring longs above 4165 and shorts below 4080.
If the ol' Purple Pivot Line still has validity, we have the potential for a really nice area of confluence setting up towards the end of this week. If we hit that line while under or near 4080, I will be taking aggressive short trades only. We might even get a little clue under 4095:
This Delta by Price chart from last week doesn't really tell us anything, as the buying and selling was fairly balanced throughout the week. This makes sense given the epic battle that we watched, back and forth. However, there was one sizable sell delta print near the lows (lol it's always at the lows, isn't it?) and should the sellers push price through 4095 again I'll be looking to see if things accelerate very quickly down to 4080, confirming the short bias underneath that level.
We also have a "Balance Zone within a Balance Zone," which is easier to see on a TPO Chart. In practical terms, since this TPO Balance Zone is inside the 4080-4165 Balance Zone I showed earlier I will absolutely not be initiating trades inside 4150-4158. I know that's a very small range, but hopefully it saves you a couple points this week...I think that's a clear "No Trade Zone" based on the charts.
The chart above (showing weekly volume profiles and the YTD profile on the far right) shows us a couple interesting things. First, the leftmost profile (last week) shows us a very balanced distribution, aka the market is in a "holding pattern," likely waiting for CPI/PPI this week and cooling off a bit after an epic bear market rally.
Region #1 Above: If you look close, you can see a very flat shelf on the YTD profile. Believe it or not, this is bullish in nature and should give us confidence to lean into longs above 4160, or the 4165 level that I'm waiting for (just to be safe).
Region #2 Above: 4040 represents the lowest Low Volume Node (LVN) on the YTD profile, and we also have an interesting anomoly right above it, with a Bearish HVN on top of a Bullish HVN. The Bearish HVN starting at 4080 should give us confidence to lean into short trades under that level, especially if they break that shelf at 4070. If this trade works out I will absolutely be taking some profit near 4040 and watching for a rebid. If we get a selloff this week but the buyers aren't done yet, I strongly think we'll see them step back in between 4040-4045. Certainly not telling anyone what to do, but I'd mark that region on your chart if I were you.
Before you start thinking I'm super bearish, let's talk a little about upside targets:
Just to be clear, there's nothing bearish about this rally so far on ES_F. My downside scenarios listed above are meant to help us prepare, not predict. I still strongly believe that as long as we're above 4075-4080 the bulls are without a doubt in control.
When I posted this Tweet, I was referring to the noticeable change from "Sell the Rip" to "Buy the Dip" that we've seen over the past couple of weeks. If you stare at a DOM long enough, you start to notice these subtle changes in dynamics that can help your day trading. Will this dynamic change last? I have no idea, but until it changes again the buyers are firmly in control. Based on what we've seen over the past few years, they can keep that control for much longer than anyone would expect.
Ok back to that chart above: I've been talking about 4224 for a couple weeks now, and should we see it this week it would coincide with a +1 Fib extension from last week's trading range...that's pretty cool. If we get the breakout over 4165 I will be taking the majority of my long positions off at 4224, leaving a piece to ride to that red sloping line.
The challenge with bear market rallies is everyone's trying to figure out when to sell the next rip...this can often exaggerate the move upward if shorts continue to take shots and cover. To me, that downward sloping red line would represent an "extreme" point where selling would be very likely. I also think people tend to try and fade rallies too early. Remember, there's a very real delayed effect in the markets, meaning your average Mom & Pop retail investor/speculator is JUST NOW processing this recent rally and I wouldn't put it past Wall Street to let scores of Dentists and shoeshiners FOMO back into equities before the serious selling starts.
There's absolutely no reason to rush to be the first seller, especially when the buyers have the upperhand. Wait for one of those sessions where the indices can't seem to get off the ground, where the sellers are in control relentlessly hammering price down...remember, there's almost always continuation after that. FOMO happens on both sides of the market.
I'll be using 4080 as my Weekly Pivot this week, but waiting for a break above 4165 before I engage in any aggressive longs.
As always, stay safe out there. This week is likely to be another wild one!
Happy Trading,
Horse