Stock Market Commentary
The stock market’s dip into oversold territory lasted the typical one day. The immediate wake was ugly. The follow-through revealed a new divergence. The resulting oversold bounce carved out the S&P 500 for special status as the winner of the divergence. The index hit an all-time high while the majority of the stock market churned its way into the close of the week. The stalled indicators of market breadth presented a stark contrast to the continued momentum of the S&P 500.
The Stock Market Indices
The S&P 500 (SPY) gained 4 out of 5 days in the week. The push from oversold trading conditions was just enough to earn the index an all-time high. Despite the fears at the time, the S&P 500 held support at its 50-day moving average (DMA) (the red line below) like all but one other visit to this support line during the pandemic. This predictable pattern continues to astound me. The S&P 500 is now poised for a run to 4760 and higher to close out the year.
The NASDAQ (COMPQX) sprinted higher with the S&P 500 on Tuesday. However, the tech-laden index essentially stalled out from there. The NASDAQ is burdened with the expensive growth stocks that are falling out of favor again. Inflation fears and the overdue response from the Fed are dampening enthusiasm for paying any price for growth and reducing the tolerance for unprofitable companies. Still, the NASDAQ is close to “escape velocity” from the oversold trading period. The index just needs a second higher close above its 20DMA (the dotted line).
The iShares Russell 2000 ETF (IWM) looks ready to get boring within its trading range. The 200DMA (the blue line below) acted as effective resistance capping the bounce from oversold conditions. I learned a lot of lessons trying to chase IWM around this year. I will stick to buying this index of small cap stocks near the bottom of the trading range until the price action changes significantly.
Financials bounced with the rest of the market but stalled out quickly like the NASDAQ. The SPDR Select Sector Fund (XLF) shied away from 50DMA resistance. Perhaps XLF is anxiously awaiting the results of the coming meeting of the Federal Reserve.
Stock Market Volatility
The volatility index (VIX) surprised me with a second surge on its way to topping out just under its highs of the year. Similarly, the VIX surprised me with the swiftness of near inevitable subsequent implosion. The faders were so strong last week that the VIX barely had a chance to breathe at the critical 20 level. The VIX closed the week at 18.7, a 39.0% loss for the week.
The Short-Term Trading Call With A New Divergence
- AT50 (MMFI) = 33.9% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) 42.1% of stocks are trading above their respective 200-day moving averages
- Short-term Trading Call: bullish
AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, closed the week at 33.9%. The oversold bounce into an ugly stock market quickly transitioned into a divergent market. The S&P 500 managed to sprint and then crawl its way over the hump to a new all-time high. The index left behind the majority of the stock market as AT50 sharply pulled back to 33.1 and then churned on Friday. This new divergence creates the prospects for an end-of-year rally that leaves a lot of people unsatisfied and restless for a strong start to 2022.
All of my oversold trades on the indices generated profits with a wide range of results. The trades once again demonstrated the benefit of sticking with the AT50 trading rules. While I was far too eager to take profits on my SPY calls on Monday’s rally, I closed out the short put spread close to maximum profit. I sold my IWM calls just ahead of the pullback. After accumulating shares in the ProShares Short VIX Short-Term Futures ETF (SVXY), I took profits on Tuesday. The VIX turned out not to have any fight in it. Accordingly, I could have sat on my hands the whole week.
The biggest disappointment was my QQQ weekly calendar call spread. I targeted the $290 strike assuming that tech stocks would churn last week and then resume the oversold bounce next week. Instead, QQQ gapped well above $290 on Tuesday and never looked back. I took minimal profits on Friday.
Be careful out there!
Footnotes
“Above the 50” (AT50) uses the percentage of stocks trading above their respective 50-day moving averages (DMAs) to measure breadth in the stock market. Breadth defines the distribution of participation in a rally or sell-off. As a result, AT50 identifies extremes in market sentiment that are likely to reverse. Above the 50 is my alternative name for “MMFI” which is a symbol TradingView.com and other chart vendors use for this breadth indicator. Learn more about AT50 on my Market Breadth Resource Page. AT200, or MMTH, measures the percentage of stocks trading above their respective 200DMAs.
Active AT50 (MMFI) periods: Day #417 over 21%, Day #5 over 31% (overperiod), Day #11 under 40%, Day #15 under 51%, Day #17 under 60%, Day #197 under 72%
Source for charts unless otherwise noted: TradingView.com
Full disclosure: no positions!
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*Charting notes: Stock prices are not adjusted for dividends. Candlestick charts use hollow bodies: open candles indicate a close higher than the open, filled candles indicate an open higher than the close.
Thanks for the post. You often talk about your call/put spreads and your calendar spreads. Benefit appears to be decreasing your risk:reward rat or so that if you are correct 50 percent of the time you win in the long run. Do you have past post with ins and outs of spreads?
When volatility is high, I prefer to use spreads to reduce cost. In the past, I have found that I can be directionally correct, but lose money because I get caught in a volatility implosion. Great idea to do a post focused on the ins and outs of spreads. Starting in 2020, I started using calendar calls. This year I started even selling spreads in some cases. So my learning continues.
Follow up question….
When you speak of divergence, for your rules you specifically mean the daily MMFI went down and the SPX went up? And when you say short term bullish based on AT50 you are referring to bullish call on SpX?
Correct on being bullish the S&P 500. My bullishness also applies to individual stocks with attractive entry points. I am also more willing to bet on bottoms when I am bullish.
The current divergence is a bit more nuanced. MMFI (AT50) actually gained a little on Friday. However, it is well off the high for the week while the S&P 500 pushed to an all-time high. That’s a more important divergence than a single day.