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The Dog Days of Spring

Thu, May 8 2008, 08:07 GMT
by Online Trading Academy Team

Online Trading Academy

In the two weeks since I put pen to paper for Online Trading Academy, volume and volatility in the stock market have diminished considerably. The volatility index (VIX), after spiking into the mid-thirties on two occasions this year, has dropped below 19 for the first time since mid-December. In addition, the daily volume of shares traded on the New York exchange has been anemic - normally over 1.5 billion - it's barely eclipsed the one billion mark. I get the sense that people think the worst is behind us, but aren't quite sure if the waters are safe just yet; hence the low volume. This type of market behavior is uncharacteristic for this time of year. Usually, this level of apathy is more characteristic of the late summer when many of us are on vacation.

So what can be gleaned from these developments? For one, the Federal Reserve, by all accounts, has largely spent its ammunition on the battle to stave off further economic dislocation. The plight of the US Dollar, which is directly linked to soaring oil and commodities prices, must now be squarely addressed by the Federal Reserve in future policy adjustments - essentially rendering them immobile - on further rate cuts. That's not to say that they won't continue to provide liquidity if needed. Moreover, the housing crisis is seeing no sign of amelioration; in fact, quite the opposite is occurring. Yet, in spite of all these negatives, the broader market continues to move higher - with one exception - the small cap Russell 2000 (I'll go more in depth on this later).

In this week's piece, I'm going to discuss the importance of knowing the probabilities in trading. One of the most important attributes of a good trader is that he understands, and thinks in terms of probabilities. In any risky endeavor, the assessment of the odds serves as a barometer of conviction when it comes time to assume risk. The edge that is needed to extract capital from the markets on a consistent basis partly comes from knowing what the odds are every time we place a trade. Parallels may be drawn to a professional poker player, or perhaps a sports handicapper, who presses his bet only when he has a very high level of confidence. This assuredness is borne of the knowledge that the likelihood he'll win is much better than 50/50. It's not any different in the trading world. We've all heard the expression "the trend is your friend" which refers to the trading dictum that if you trade in the direction of the trend, your odds of making money increase. For the most part this is true; however, the tricky part is in indentifying if the trend is an infant, teenager, middle-aged or elderly individual. Perhaps the aphorism should be "The trend is your friend 'til the bend in the end". Along with trading with the trend, we pros know that buying at support in uptrends and shorting at resistance in downtrends can also improve the chances for profitability. Given this information, it is imperative that you know what the probabilities are for every set-up you trade. If you don't, you're trading strictly on luck, and we all know that "luck" eventually runs out.

Let's change gears once again and review the technical picture of the ER2 (E-mini Russell 2000). In the daily chart below, notice the ER2 had a minor breakout of the range that's been in place for the last couple of months. The jury's still out on whether this is a false breakout. As often times when price pierces a major resistance, it tends to come back in to the range before resuming its original path.

As I noted earlier, the Russell is still range-bound for the most part, whereas the S&P and other major Indices have decisively broken out of their consolidation patterns (chart below).

The last chart we'll peruse is that of the E-mini nasdaq 100 (NQ) below. Of all of the indices, this tech heavy index is by far the outperformer. This is largely due to stellar earnings releases by some of the big cap tech names, which generate a disproportionate level of revenues from foreign customers.

To Recap: The earnings season is winding down, all in all, it wasn't as bad as many people expected. The usual suspects continued with their write-downs, but that wasn't anything new. At this juncture, the market has discounted most of the earnings. Now, the focus will turn to other pressing issues, namely, the price of oil and what effect it may have on the consumer. Technically, the market is looking tired. The complacency as measured by the aforementioned VIX and the tepid volume is troublesome; however, this doesn't preclude the market from continuing to rally. My view is that we will need another shock to the system to trigger the next correction. What that will be is unknowable, so for now, the highest "probability" is to buy on support and take profits at resistance.

Until next time, I hope everyone has a profitable week.

Published on  Thu, May 8 2008, 08:14 GMT

Archive

• Trends, Gaps, and Probabilities...
  Published On Mon, Oct 6 2008, 10:10 GMT
• The Good, the Bad and the Ugly!
  Published On Thu, Oct 2 2008, 06:31 GMT
• ATR and the TED Spread
  Published On Wed, Oct 1 2008, 06:30 GMT
• Trading and Gambling
  Published On Tue, Sep 30 2008, 06:15 GMT
• Bailouts, Bankruptcies, and Bureaucrats
  Published On Thu, Sep 25 2008, 06:20 GMT

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