Three Pigs

Volatility is continues to reverberate through equity markets evidenced by fickle participants who hastily take profits after one or two sessions of directional tape. And most likely this is the new normal that we need to come to expect. If nothing else then the erratic swings throughout 2018 clearly tell us that the easy days are officially behind us.

In that context let’s also look at implied volatility and how it has evolved over the past year. Note in particular the VIN/VIF and VIX/VXV left ratio charts, both of which have clearly remained elevated since the late January surprise. What’s most telling here aren’t the spikes up but the baseline which only once dropped < the 12 mark (it’s plotted on the VIX price range, so the actual ratio is different).

All that of course is a far cry from the record low readings we enjoyed for weeks on end until late last year. But that changed mid January and I am afraid it’ll be a long time until we see anything even close to a VIX reading near 9 again.

Which I also doubt that things are going to get much easier for us moving forward. Right now we are looking at three possible scenarios – I call my three pigs, and I’m going to give you their respective probabilities as well.

  1. Green Pig: We scared the children and it’s continuation higher starting today or Monday. This scenario gets 40% right now but starts diminishing rapidly after a drop < ES 2760.
  2. Orange Pig, a.k.a. the inverse H&S pattern: Down we go, we breach ES 2760 and then drop into 2720 where we produce some sort of spike low, followed by a bounce higher that exceeds 2820 and then it’s off to the races.  Odds here are around 40% as well, gaining a lot more credibility below ES 2760.
  3. Red Pig: Down down and then down some more. This scenario only stands at 20% right now but starts gaining traction after a drop through ES 2680.

Given all this my current trail near 2770 would weather out the green pig scenario but not the orange one. Which is by design as dropping my stop this low would rob me of most of my profits and not accomplish too much. Best to lock in my 1.2R and come back to the table if I eventually see a spike low forming.

I leave you with our historical stats chart which is not looking very supportive for the next week. It also shows that equity traders have effectively blown half of one of the most profitable buying streaks of the year. So yes, anything can happen here – and judging by what’ve put up with over the past few months odds have it that it probably will.


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