T2108 Update (March 7, 2014) – Overbought with Caution

(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are posted on twitter using the #120trade hashtag)

T2108 Status: 74.2% (4th overbought day)
VIX Status: 14.1
General (Short-term) Trading Call: Long
Active T2108 periods: Day #169 over 20%, Day #15 over 60%, Day #4 over 70% (overbought/overperiod)

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary
My first round at playing an extended overbought rally was a small success. I started a small tranche of ProShares Ultra S&P500 (SSO) call options on the first dip of the overbought period. I promptly sold them after Friday’s higher than expected jobs number failed to inspire a gap up or even a strong open. A limit order to buy into any dip on the day failed to execute. Going forward, I will continue the aggressive dip-buying until it fails to work.


So far, so good for the overbought period
So far, so good for the overbought period

While the S&P 500 (SPY) managed to close at a new all-time high (marginally), T2108 took a dip to close the week at 74.2%. This mild bearish divergence is a yellow flag. The VIX is also hanging tight. After Tuesday’s drubbing, the volatility index has closed at almost the same level the last three days.


The VIX stabilizes a bit even as the overbought period completes its fourth day
The VIX stabilizes a bit even as the overbought period completes its fourth day

It is hard to know exactly what the VIX stabilization means, if anything. But combined with a tick downward in T2108, it makes sense to stay on the lookout for a sudden drop out of overbought conditions. Without such a drop, the trading call remains bullish.

Almost in the bull’s corner is AUD/JPY, the Australian dollar (FXA) versus the Japanese yen (FXY). On Friday, AUD/JPY surged and essentially tested the upper portion of the presumed trading range. I have argued in several places that a breakdown/out of the AUD/JPY trading range would carry significance for the stock market. Breakdowns have worked like a charm as well as bounces out of the breakdown. Bulls can see Friday’s retest as the first phase of an eventual breakout. Bears can see Friday’s failed retest as a signal the rally has finally ended. This coming week’s follow-through should be telling. Note that I took this opportunity to finally close out my long AUD/JPY position. I will slowly rebuild it on dips as a trading range play and hedge on my net short position against the Australian dollar.


AUD/JPY fails a retes of the top of its trading range....but is a breakout looming anyway?
AUD/JPY fails a retes of the top of its trading range….but is a breakout looming anyway?

Now some quick chart reviews:

The bond rally for 2014 may have finally ended. iShares 20+ Year Treasury Bond (TLT) put in an ominous double-top formation and is breaking down below its 200 and 50DMAs.


TLT hits a ceiling
TLT hits a ceiling

Higher rates could be re-generating fears for housing. Since I think an extended rally for home builders will occur alongside a general stock market rally, I loaded up on some call options on iShares US Home Construction (ITB). This is a play on the 20DMA holding as general support.


ITB needs to hold the 20DMA to maintain a robust rally. Otherwise, more rangebound trading could be ahead...
ITB needs to hold the 20DMA to maintain a robust rally. Otherwise, more rangebound trading could be ahead…

I conclude this short update with the incredible post-earnings chart of Skullcandy. At the time of writing, I have a pending post with Seeking Alpha discussing the earnings that generated the surge and fade on Friday. At one point, SKUL was over 50% up for the day! I always make the point that stocks gapping well above or below the upper-Bollinger Band (BB) should be faded. In the case of SKUL, a short position would have experienced a wild ride, but in the end would have been profitable almost no matter when the fade was entered: SKUL closed at its low of the day. It never even occurred to me to try a fade because I was just looking for a point to lock in profits on my long position…


A dramatic cap to the 2013 turn-around for SKUL
A dramatic cap to the 2013 turn-around for SKUL


Daily T2108 vs the S&P 500
T2108 vs. the S&P 500 (DAILY)

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SSO puts and calls, long UVXY shares, net short the Australian dollar, net long Japanese yen, long ITB call options, long put and call options on TLT

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