Friday was the 2nd outside day in a row. Looking back to the inception of the SPY, other times there have been back to back outside days have typically been followed by rallies over the next few days. The study below illustrates this.
A subscriber recently asked me about my take on position sizing, and more specifically using Optimal f. For those unfamiliar, Optimal f is a calculation derived by Ralph Vince which computes the optimal position size that would lead to a portfolio’s fastest growth rate. Mr. Vince has written several books on the subject and I do recommend his work.
Here’s my take on using Optimal f (or any other position sizing formula for that matter).
Optimal f may be the mathematically optimal size for a position IF the trades are managed in an optimal manner. For many people, positions of “optimal” size feel aggressive. While our perception is often that we have a large edge on a particular trade or strategy, the edge often isn’t THAT great. In order to maintain your edge you need to be able to trade the strategy in an “optimal” manner. Whether the strategy is automated or discretionary doesn’t matter. You need to be able to take entries when they trigger. You need to be able to take exits when they trigger. But just as important and sometimes most difficult is you also need to be able to SIT when there is neither an entry nor an exit triggering.
The sitting can often be difficult when traders have what they perceive as a large position that they are managing. Many traders have a tendency to want to manage the trade more carefully with large positions. This may mean tightening stops sooner or taking partial profits a little quicker. Doing this “feels” good and it may get the trader to a breakeven level faster, but in the long run it will almost always either reduce or destroy the edge of the strategy. Tighter stops and quicker profit taking effectively means more losers and smaller winners. Few strategies can withstand more losers and smaller winners and still look good.
Optimal f may be the mathematical optimal size, but in my view the optimal size is the closest you can get to Optimal f and still execute your strategies as they were designed – while keeping your sanity.
A trader I know pointed out the unusually large gap activity lately. I track the 10-day absolute average gap over the 100-day absolute average gap on the charts page in the members section of the site. Meanwhile I observed the average true range is still below normal. I’ve copied the two charts from the website to illustrate.
The real odd behavior here is with the average gap size. Such gappy behavior is unusual with the market near new highs. It’s also unusual when there isn’t also a substantial increase in the intraday range. I looked at this a number of different ways last night. The 10/100 Absolute Avg Gap is 1.38 (meaning the 10ma is 38% larger than the 100ma of the overnight gap size). I looked at other instances where similar levels were approached and the market was near a new high. It’s been fairly unusual over the last 15 years and results were inconclusive.
I then look at comparing the size of the average gap to the size of the average intraday range (not the true range as shown above). Here again I found we are at very high levels but past history was choppy and inconclusive.
Lastly I looked at times where the 10-day average gap was well above normal and the 10-day average intraday range was well below normal. Again I could find nothing suggesting a significant directional edge.
So is this activity suggestive of anything? Perhaps. While the readings themselves don’t seem to help greatly in predicting direction, they do indicate some unusual behavior. My take is that the market is being influenced more by outside forces than is customary. It’s been noted by many that the dollar has been leading everything by the nose lately. Outside influences like Dubai debt have also had an overnight influence lately. This would seem to explain why such a large percentage of action is occurring overnight.
So what should we do about it as traders? Two things come to mind – 1) Be more cognizant of dollar and other intramarket action. 2) Perhaps don’t put quite as much weight on standard price, volume and breadth indicators as usual. The studies have done quite well as of late. Still, it may be worth trading with a bit more caution than usual until the stock market manages to decouple from the dollar a little bit.
Friday’s selloff was marked by extremely negative breadth. Around 97% of the volume was to the downside on the NYSE. In the past, days that have been SO negative have often led to bounces over the short-term. This can be seen in the study below.
The “% Profitable” is positive but not overwhelming. Risk/reward is pretty solidly bullish, though with the”Avg Trade” showing some strong numbers.
In September as part of his trader interview series, Charles Kirk of The Kirk Report interviewed me. Charles has been kind enough to allow me to republish the interview, which previously was only available on the members section of The Kirk Report.
If you’ve ever had questions about my approach, then be sure to check it out. Charles probably got the answer out of me. Even those who are very familiar with my work will find new material in the interview. Charles got me to discuss ideas and methods that I’ve never discussed on the blog or in the Subscriber Letter before. The interview is lengthy, but with the slow trading and extra time off over the next few days I thought some readers might find it interesting. There is a link below, and I have also posted a permanent link on the Quantifiable Edges home page.
https://quantifiableedges.com/kirk-hanna.html
Happy Thanksgiving!
I wanted to briefly discuss the Vegas Traders Expo I attended last week. I enjoyed the Expo greatly. While there was a good number of unsubstantiated claims by certain speakers, I was pleased to see that several speakers took the time to quantify their methods. Two that come to mind were Larry Connors and Buff Dormeier.
Larry discussed some of his TradingMarkets work.
Buff discussed his Volume Price Confirmation Index (VPCI), which he won the Charles H. Dow award for in 2007. For those who may not have read Mr. Dormeier’s paper I would suggest it. It may be found using the link below:
https://www.mta.org/eweb/docs/2007DowAward.pdf
In fact, all past Dow Award winning papers back to 1994 may be found here:
https://www.mta.org/EWEB/dynamicpage.aspx?webcode=charlesdowaward
Other traders whose work I respect greatly and had a chance to meet and talk with at the expo include:
Scott Andrews of Master the Gap. Scott’s focus is trading the opening gap – primarily in the S&P futures. He uses statistics and backtesting to develop his techniques.
Tim Bourquin of TraderInterviews.com – a unique site that interviews traders to provide insights into how they make money.
Dave Mabe of Stocktickr. The Stocktickr product helps traders to track, segment and journal their trades. I strongly believe it’s important to understand what’s working and what isn’t among a traders strategies and this product seems to do a nice job of assisting with that.
Corey Rosenbloom of Afraid to Trade. Corey focuses on intraday trading and technical analysis. He looks for trade confirmation using several techniques including Fibonacci, Eliot Wave, and tick analysis.
I also enjoyed meeting and speaking with several Quantifiable Edges readers and subscribers.
Seasonal influences are often cited around the Thanksgiving holiday. Therefore I decided I would examine returns during Thanksgiving week as well as the Monday following. Below is how the SPX has performed around Thanksgiving over the last 48 years.
Monday and Tuesday don’t seem to carry a sizable edge. Monday’s total return was actually negative prior to 2008 when it posted a gain of over 6%. Also notable is that the Monday AFTER Thanksgiving’s stats were skewed a bit by the 2008 results. Last year saw a drop of over 8% on that day. Even excluding 2008 there is a bit of a bearish edge apparent on the Monday following Thanksgiving.
The market is off to a strong start today. The NYSE Tick did not post a negative reading for the 1st half hour of trading. This is fairly unusual, having happened only 64 times since the beginning of 2005. Below are stats showing how the SPY has performed the rest of the day after the TICK got off to such a strong start.
Nearly 2/3 of the time the market has managed to follow through with more gains from 10am until the close. Stats are a little skewed by the huge 7.5% gain that occurred on 10/13/08. The average loss was fairly small at around 0.5%. Overall, a very positive start like we’re seeing this morning has often been good news for the rest of the day.
Of course there is a little speech today from Chairmen Ben…
Research posting may be light this week as I travel to the Las Vegas Traders Expo. My presentation will be Thursday at 1:15pm. As well as discussing some concepts and edges I’ve covered here or in the Subscriber Letter over the last few years, I’ll also be unveiling some new research. I’m looking forward to meeting readers and subscribers at the show.
I may act more as a reporter/blogger later this week and provide some thoughts about the show and my experience there.
Notable about Friday’s action was that volume was again light on the rally. This has often led to a short-term pullback in the past. Below is a link to an April 2009 post that looked at SPY action as was seen on Friday. The study was one of several identified by the Quantifinder on Friday.
https://quantifiableedges.blogspot.com/2009/04/is-buying-drying-upagain.html
In a somewhat unusual move, while the SPX was closing at a 50-day high yesterday, the VIX actually closed higher. Below is a look at other times this has happened during the middle of the week.
These stats suggest a downside edge. Apparently the VIX should not be on the rise when the SPX is hitting new highs. The fact that it rose Wednesday implies a short-term pullback.
The last couple of days I’ve published some bullish studies that showed Nasdaq breadth data and VIX action were indicating further rises. The market followed up by meeting the objectives of these studies very quickly. Today I’ll mention what’s NOT so great about this rally – volume. On Friday NYSE volume came in low. While it rose some Monday, SPY volume faltered. It triggered a couple of bearish studies that were identified by the Quantifinder. I’ve linked to those studies below.
This first one looked at declining volume on a streak of higher closes.
https://quantifiableedges.blogspot.com/2009/09/spy-rising-while-spy-volume-declines.html
The second one looked at 20-day volume lows when the market is in the upper end of its range.
https://quantifiableedges.blogspot.com/2009/04/is-buying-drying-upagain.html
So while other indicators have been positive, volume is currently the squeaky wheel.
The VIX has moved from overbought to oversold quite quickly this past week (based on its stretch above and below the 10-day average). This brings up the question of whether the now “oversold” VIX is suggesting a selloff for the S&P. I took a look at similar past situations.
Results have been inconsistent but risk/reward has generally favored more upside over the coming weeks. This would seem to make sense since what you’re typically looking at in the SPX with the above setup is a strong rebound from a sharp decline during a long-term uptrend.
I am seeing some signs the market is nearing a pullback. The VIX action is not one of those signs.
While most everything did well on Thursday, much of the excitement was directed towards smallcaps and Nasdaq stocks. Below is a little study that shows how the market has performed in the past following such buying interest in the Nasdaq while the S&P 500 was in a long-term uptrend.
Instances are lower than I’d typically like to see, but with all 7 closing higher in the next day or 2, this study appears worth noting. Extremely strong volume breadth going into riskier Nasdaq stocks has often led to some follow through when the market is in a long-term uptrend.
I am off this morning to go get a root canal, so no time for anything new. With the Fed announcement coming later today, you may want to review some of the old Fed Studies.
So I’ve been asked a few times, “what has been happening with the Capitulative Breadth Indicator (CBI)?” No I haven’t stopped tracking it. There just hasn’t been a significant reading since the March bottom. Below is a chart I post to the members section of the website every night.
As long-time readers may recall, I don’t normally view CBI readings below 5 as any kind of warning sign. It’s not until readings reach 10 or more that they become highly indicative of an upcoming oversold bounce. We haven’t seen a reading above 4 in almost 8 months now. Even the current selloff has only seen the number move up to 3. It also appears unlikely to move substantially higher in the very near term. While other breadth readings like the McClellan Oscillator have been reaching extreme levels, the CBI requires more intense selling among individual issues – not just a broad decline. I’ll discuss the CBI again when more significant readings arrive.
For those who would like to learn more about this inidicator, you may check out the CBI label on the right hand side of the page.