Market Prep: Week of July 11, 2022

Thought the fireworks ended during the week of 4th of July? I doubt it. I think we're in store for some serious market "fireworks" this week with CPI, PPI, and Options Expiration on deck.

This week's Market Prep is going to be a little different as it won't be very chart-heavy. Instead, I want to do my best to simplify what I'm looking at as much as possible and focus more on strategy. Apologies in advance if this week's article isn't what you're used to or prefer, but I think it's prudent to change gears given the trading week ahead of us. What am I talking about? I was chatting with a fellow trader about some recent FinTwit drama (or "war" lol) and they made a good point: Too many traders just spew out levels and don't discuss how they plan to trade them. I think that's a very valid point and unfortunately true. Obviously I use price levels to trade, but I too am guilty of assuming people understand how to trade off them. So this week I wanted to talk more about strategy since there's a couple of specific market "events" this week. What events? CPI on Wednesday and OpEx on Friday. Given the state of the markets and inflation, these are pretty significant events for the week ahead and potential money-making opportunities if we have a plan. I'll talk about each of them individually, but first let's start with the big-picture in terms of strategy.

What's My Position Size Going to be This Week?

Answer: Small

Why? Let me show you:

This Daily SPX chart simply colors the bars based on whether we're over 50 on RSI or now. We recently (finally) had 2 closes over 50, which is typically a good environment to size up and favor long trades. Models are cool...but knowing when to ignore them is even cooler. Why ignore it and continue trading small? Because nothing about the week ahead indicates low volatility, and during periods of high volatility I prefer small positions with wider stoplosses. With CPI & OpEx this week, there's a very high likelihood the market will move, and I don't think a +/- 2% day is out of the question. So first things first in determining our trading strategy: Fade the RSI "rule of thumb" and continue to keep position sizes small, otherwise aggravating stop-outs are very likely and I want to give my trades enough room to breath this week to see my thesis play out (more on that later).

Another reason why I expect volatility this week is because literal volatility could be considered a little "cheap" right now:

The Daily SPX chart above shows VIX, Implied Vol, Historical Vol, and the Relative Volatility Index Indicator (RVI). It's hard to call VIX "cheap" with a straight face when it's just under 25, but when we compare it to historical and the RVI we can see the "Vol Crushers" had a productive week last week. I've talked about RVI in the past and while I don't think it's a great indicator for a top or bottom, when it reaches extreme levels it's usually pretty reliable within a week of trading to show us that one side (buyers or sellers) are starting to lose steam. You can see in the bottom right that we're nearing one of those extremes. Long story short, I wouldn't be surprised to see large participants reloading options at the tails during and after an OpEx week...possibly even leading up to the CPI data drop.

Ok, so we've established that position sizing will be small and stops will be wide to account for expected volatility, now we can focus on where we want to trade. To determine this, let's start with our 1hr ES_F "Range" chart:

Instead of a Weekly Pivot level this week, I'll be using a Pivot Range (basically 2 levels, represented by the Red and Green lines above). Why? Because 3900 is a blatantly obvious magnet for price given the mass amount of options traded at that strike and the large High Volume Node (HVN) on any timeframe Volume Profile you look at. It's going to be a choppy level, and since we're talking about strategy a lot this week then we have to acknowledge areas of likely frustration...3900-3905 is one of them. Unless you're already in a trade it's best to avoid areas where it's easy to anticipate choppy price action. Determining a Pivot Range like this one from 3875-3922 will help guide my bias. As long as price is close to 3900 I have NO IDEA which way it will break, but I know I want to ride the coattails of whichever side gains control. Above 3922 and I think there's a strong possibility that 4000 trades this week, with possible overshoot levels at 4020 and 4080 (i.e. levels that could trade before pulling back to 4000). Below 3875 and I am interested in capturing those 50pts down to 3825. Let's look at a different view to show you why:

There's 2 main things to note on this 2hr ES_F Chart: The last 2 week's profile shapes and the potential wedge formation. Looking at the Weekly Volume Profiles we can see 2 very clear clusters of volume at 3905 and 3825 (remember the big player iceberging 3825 over the past couple weeks?). Remember, I view Low Volume Nodes (LVNs) as Decision Points for the market...it's going to be forced to make a choice there. Do buyers step in a push price back up to 3900 or do sellers regain control and push us back down to 3825?...because we sure as hell won't be hanging out long in an LVN. So, below 3875 sets up well to favor short trades and selling rips, in my opinion.

The second part of the chart above worth talking about is the wedge formation. This is where strategy comes into play: We are looking for Time + Price = Confluence.

What do I mean by that? Well there's 2 key levels of confluence that could coincide with the top of that wedge: 1. The 50DMA (currently ~3975) and 2. 3950 (which we've recently rejected twice). If price hits the top of that wedge when the 50DMA is there, depending on if I'm already in a 30min Opening Range trade, I will either lighten up and cut size or if I'm flat at that time I will scalp short at that level. Yes, even though we'll be above the 3922 Pivot Range level. You see, this is the nuance I want to share with you because yes I talk about key levels a lot but it's not always as black & white as "long above short below," a good trading plan should involve anticipating exceptions based on strong areas of confluence. Sometimes I get comments from people like "I went long above your pivot but then it pulled back to the pivot" and I think "Well yeah price hit a significant level of confluence up there, did you not see that?" The trader I referenced earlier that said "too many traders are just spewing levels" is absolutely correct...trading is tougher than that and the difference between a truly great trader and an average trader is the ability to anticipate likely areas where the market will have a reaction and pivot accordingly. Anyway, wedges like the one above can be strong, so I personally prefer to either lighten up or play the rejection upon the first touch, especially considering the culmination of the wedge wouldn't happen this week if the pattern is valid. The reason why I'd fade the top of the wedge is because the pattern hasn't been firmly established yet and I'd know quickly if I was wrong and if the wedge is valid.

Ok, back to our 3875-3922 Pivot Range. Let's look at it from another angle to see why I like it so much:

The 1hr ES_F Chart above shows Delta by Price for last week's trading. We can see one part of the histogram on the right is distinctly different from the rest...that's right, our 3875-3922 range. This range is littered with aggressive sellers that showed up towards the end of the week. If any of these aggressive sellers were shorting, it's likely they'll be forced to cover some if price gets above 3922, which could provide the fuel needed to reach the ever-important 4000 level. Same can be said about the flipside: If the sellers "win" this battle and push below 3875 all of those aggressive buyers right below will start feeling some heat. And where do all the big orders end? You guessed it: Right above 3825. Remember how I thought 3760 was the level for bulls to hold? I think that's 3825 now...below that is "No Man's Land" and 3760 could come very fast if sellers regain control this week.

Ok, back to discussing strategy for our 2 events this week.

CPI: I'm not going to waste your time speculating about what the CPI print will be, I have no idea. What I do know is this: Someone usually always knows. Therefore, I will be watching closely for clues 24hrs prior to the data drop. What do I mean by clues? Aggressive price action dominated by one side, typically blowing through levels that we'd anticipate price to have a reaction. The wedge we discussed is a good example. If we blew through either side of that before Wednesday morning that would act as a clue for me.

"Wedges be damned CPI is coming is HOT/COLD and I want to position NOW" - Wall Street, probably.

I actually think this aggressive action is easier to see than you might think. The reason I say that is because it's very common for price to "hold steady" prior to a major news/data release...so if it doesn't that is probably a clue that someone knows something they shouldn't. It's happened before, I wouldn't rule it out. As traders we need all the clues we can get to have an edge. Look for very large Delta by Price prints if someone knows. To round out the discussion on CPI strategy, if I don't see any obvious signs that someone knows something then I'll be flat before 8:30AM Wednesday because in my experience the gamble isn't worth it. OpEx: In terms of strategy, I typically try to lay low during OpEx weeks because I hate them, but this one is interesting. It's curious that the most influence options position is at 3900...where we will start trading the week from. Soooo are we just gonna chop around 3900 all week? Maybe, but unlikely. So where would we go? Obviously I don't know, but put it this way: A trip to 4000 should not shock you. Here's my thinking...

There's one major trendline on the Daily ES_F chart above that the market has interacted with the most for the longest and I suspect we aren't done with it. What's interesting is that 4000 coincides with a Friday close at the S/R Line. Curious...

Also, when we look at the Open Interest on SPX options, 4000 has quite a bit of "interest" despite currently being 100pts below that. Also curious...

I'm just sayin' don't let it shock you. OpEx Friday's have a tendency to surprise a lot of people and I'd hate for that to be you. Strategy-wise, I would not want to fade a rally above the "Obvious Resistance" line on the chart above. Like we discussed earlier, I think there's reason to short scalp that line (top of the wedge) ONCE, but I wouldn't fight it if price is trading above it...I think 4000 would be very likely at that point. Tying this back to actual trading strategy: If price action is bullish post-CPI I'll be looking at capture some upside via call options/spreads in addition to my ES_F trading. Remember, this is just speculation and preparation for different scenarios. We're obviously still in a downward trend and monetary policy no longer supports blind dip buying so be careful, but I hope you enjoyed this week's "discussion" and format. I know it's different than what I normally post, but at Traderade we don't want to be amongst those traders that "just spew levels at people." We value charts, data, strategy, and explaining our thinking. Just like grade school, there's value in "showing your work." In my opinion, it's okay to have a thesis and be wrong...it's not okay to have no thesis and victory dance when you're "right." Happy Trading, Horse