David Gillie is a Contributing Editor and subscriber to the ETF Digest.
He has been an Engineering Consultant for multi-million dollar construction claims, President and Founder of Envirospec, Inc. (Robotic Pipeline Inspection Equipment) and owner of David Gillie Woodworking & Design.
He divides his time between Wilmington, North Carolina and Fort Myers, Florida.
There's a phenomena in the market known as the "Santa Rally" in December. There's a reason for this and it's not because the world or economy suddenly gets better every December.
The reason is that Fund Managers (those who manage very large 401k groups) are in a "Use it or lose it" situation.
Another big group of market movers are the Hedge Funds. They tend to use all the same data and indicators so they move like a flock. They are also highly leveraged, intensifying any directional move in the market. Their fee structure is largely based on performance, so it is in their best interest to push the market up - especially for year-end reporting.
This week's rally brought the .VIX below 30 for the past three days and trending lower. This could well signal an "All Clear" for a lot of money to be put into the market that's been sitting on the sidelines during this four month period of high volatility. With that "Institutional" money coming in, Hedge Funds have a base where it's likely not to tank rapidly and they can come in and leverage the market even higher. Additionally, this week's rally created bullish crossover in several indicators (MACD, Stochastics, DI +/-). The one thing we're lacking for a breakout above resistance is volume. The S&P500 (SPY) traded 159 million shares over the past two days. It usually requires an excess of 200M shares for a reliable breakthrough.
Europe is still a mess, but the market has become numb to the daily rumors. The one headline they did respond to was the indication of a global Quantitative Easing by central banks. The market heard "Free Money" and it likes that better than a fat kid likes birthday cake. Another European summit is scheduled for Friday. They've now had more summits than Rocky sequels.
On the US front, despite chatter by the ratings agencies of downgrades, economic data has generally been in line with expectations - not great, but baby steps toward recovery. Nobody believed unemployment dropped to 8.6%, but it's good for campaigning over the weekend and feel-good for holiday shopping. It will be revised to the truth next month.
We also have another problem on this chart (other me junking it up), there are two big gaps - Monday's open and Wednesday's open. The market doesn't like gaps and will usually retrace to fill them - although, not always immediately.
Market sentiment is currently cautiously bullish. That's actually a good thing. It's when the market is at extremes of bullishness or bearishness that we invariably see a reversal. We can also see that we are about mid-way through the channel. That gives us some degree of assurance that we are unlikely to see a catastrophic tank. I read a support level on SPY around 122 - which would equate to 1220 on the S&P 500, or down about 20 points from it's current level. As stated before,we're at a triple resistance level. IF we break through, there seems to be a relatively clear path to 130 to 134 (or 1300-1340 on the S&P) - a pretty significant move of 100 points on the S&P.
I like the leveraged issues for their performance, but they are not an identical picture of the non-leveraged issue they're based on. Case in point: Lets look at the 2x leveraged issue based on SPY (SSO).
So here is how we solve the problem of the inconsistencies in the leveraged issues.
Right about now you're saying "What the hell, he's telling me when to sell before I even bought it".
Exactly! You don't make a dime buying - you make your profit when you sell! That is how you analyze the risk/reward of a trade. In this case, should we buy at the current price, our upside reward would be about 14%. Our downside risk would be about 5%. Almost a 3:1 reward risk ratio. That's not bad and about what I look for on a trade analysis.
Here's when we'll buy SSO. We'll begin by watching the futures on Sunday night. If we see a rise in the futures, that give us a bullish sentiment for Monday's open. If we see a breakthrough of the triple resistance on volume, that will give us the market conviction we're looking for. THEN SSO is a buy. Even with lowered volatility, this market can move fast. Be sure to set your multi-contingent sell order right after you make the purchase.
Drop me a note if you have any questions.
All the best!