The VIX put in a huge spike yesterday to another new high. The SPX manage to hold above its recent low before rebounding. Below I looked at long-term VIX spikes that were not accompanied by long term SPX lows and performance moving forward:
In the past there this particular setup has provided traders an upside edge.
Here’s a chart of the Dow Jones:
Here’s another chart of the Dow Jones:
The 1st one is 1929. The 2nd one is 2008.
They sure look a lot alike to me.
On Wednesday the S&P dropped 9%. It was the 3rd time in less than a month that it dropped over 7.5%. Since my S&P data only goes back to 1960, I checked out the Dow to see if it had ever dropped 7.5% 3 times in one month. It had. Once. In the 1929 picture you see above. While history never plays out exactly the same I’m sure everyone is wondering how the current picture resolved itself in 1929. Was the initial crash low broken?
Answer: Yes. The current period compares to the beginning of November in the 1929 chart. There was one final leg down before a sizable rally ensued that lasted well into 1930.
Of course if we zoom out a bit more…
This is not a quantitative study. It is not a commentary on the state of the economy or the action of the government. It is definitely not a prediction. But if you thought there was no way it could get much worse from a long-term standpoint…well…it could.
The markets wild ride is virtually unprecedented when looking at price action. Determining the markets next move based price bars alone is difficult to dangerous at this time. My current focus is on volume. On Monday the Nasdaq rose over 11% yet the volume was the lowest in 5 days. Previously, the largest percent gain accompanied by a 5-day low in volume was under 6%.
To get a sizable number of occurrences I had to lower the % gain to 2%:
Indications are for weakness in the 5-10 days following such occurrences. Below is a table that appeared in last night’s Subscriber Letter which looks at gains of 3% accompanied by the lowest volume in 5 days:
The larger % gains showed even worse performance.
As I type this morning the Nasdaq weakness is playing out. The Dow and S&P remain higher though. NYSE volume was also fairly unimpressive on yesterday’s rally. I’d be wary of further gains on low volume. I’d also continue to watch volume for clues at a time when price action is incredibly volatile.
It’s late Sunday night and the S&P futures are up over 4%. Typically when the market gaps up by massive amounts it tends to pull back at some point in the next few days. Below are listed all instances where the SPY gapped up by 2% or more. In 19 of 20 cases it posted a close below the gap open within the next 5 days:
It seems the market is getting ready to either:
a) Complete this capitulation and reverse upwards very hard, or
b) Drop to zero and close its doors for good.
At this point I wouldn’t rule out either one. If you’re of the belief that it is more likely to reverse hard than go to zero then you’re probably in the minority. You may also find the following charts interesting. They’re 5-minute charts of the legendary reversal bottoms. Whether you’re long, short, or sidelined you may want to study them for a few minutes – in case it doesn’t drop to 0.
September 1, 1998
October 10, 2002
They didn’t all happen in 1 day. Here’s 3/12 and 3/13/2003.
One common theme I see is that once the bottom was established the uptrend stayed in tact. October 10th 2002 saw a brief and relatively minor break of price support just before noon. Other than that all the rallies held their ground throughout the day. In other words, if you’re trading intraday, a loose trailing stop may not be a bad idea. A sharp break of support seems unlikely if the market is going to put in it’s next legendary reversal.
The market is hitting massive extremes with regards to breadth, price, and volatility. Below is an incomplete list that illustrates just how severe current conditions are:
Take just about any of the conditions above, slice it in half, and under “normal” circumstances it would be extreme enough for a bounce a high percentage of the time.
Note: The top 3 breadth statistics come from Worden Bros. – T2106, T2114, & T2116.
The CBI (Capitulative Breadth Indicator) finally spiked above 10 today and hit 12. For those who are unfamiliar with my CBI indicator, it basically uses a proprietary calculation to determine how much capitulation is evident among large-cap stocks. Spikes of 10 or higher in the past have led to market bounces on a fairly consistent basis. Those who would like more info on the CBI may want to read the intro post here or the full post history here. Until Tuesday the CBI had sat relatively dormant. I had thought the market might rebound before the CBI ever hit 10 this time, but this market seems bent on marking every extreme.
Until July, buying the S&P any time the CBI hit 10 or higher and selling it on a return to 3 or lower had a perfect record. The July trade turned out to be a loser. Below are statistics going back to 1995, which is as far as I was able to accurately reconstruct the indicator. The CBI has been tracked live for about 3 years now. All trades assume $100,000 into the S&P 500.
Impressive stats, but it’s important to keep in mind that the current environment is unlike anything we’ve seen since before data exists on this indicator.
As an example of the kind of extremes I was referring to in my previous post, below is a chart of (NYSE New Highs – NYSE New Lows) / Total Issues. New Highs are in the top panel. News lows are in the 2nd panel. Total issues are in the 3rd and the net percentage is in the bottom panel. Over 50% net of issues hit new lows yesterday.
According to my data, the last time the reading was under -50% was 10/19 and 10/20/87. Prior to that was 5/21, 5/25 and 5/26/1970, which is about as far back as my data goes.
Edit: It was pointed out in the comments section that Dr. Steenbarger also noticed this. His data went back prior to 1970 and he found an additional instance.
Most every indicator I look at with regards to breadth, volatility, and price action is strongly suggesting a strong short-term bounce should be at hand. Below is a short excerpt from Sunday night’s Subscriber Letter which puts some of my thoughts on these extremes into context.
What needs to be kept in mind is that the price action over the last week has been more severe than at any time other than 1987 and then back to the 1930’s. In other words, while extreme readings in breadth, volatility, price, and volume indicators of this magnitude have almost always led to short-term upside over the periods tested, the current situation is far beyond most everything tested. Measures need to be taken to control risk. Tight stops are a possibility, but difficult to implement with such extreme volatility. I’m controlling risk by scaling in with reduced position size.
On Friday the VIX closed above 45 for the 2nd day in a row. This is the 1st time since the VIX has been measured back to in 1990 that this has happened. Meanwhile the VXO closed above 50 for the 2nd day in a row. The only other time readings this high can be seen were in a back-adjusted 1987 period during and after the crash. I ran some tests to see how the market has performed the week following back to back readings above other extremely high levels:
Including Thursday there have been 18 days since 1960 where the S&P 500 has closed down 4% or more. Four of them have come in the last 3 weeks. The only other period to come close was the Crash of ’87 when it occurred on 10/16, 10/19, and 10/26. Of the previous 17 instances, the market finished higher the next day 14 times. All instances are listed below:
Recent volatility is tremendous, and this is just another example of it.
With such volatility comes opportunity. When looking to take advantage of edges during extreme periods such as this, traders need to make sure they are comfortable executing their plan. Otherwise they could end up as part of the panicked crowd. Trading while in a panicked state simply isn’t conducive to optimal decision making.
One last tip. Bailout news tomorrow could make for fast market conditions. Traders may want to place any stops they are planning ahead of the news. Otherwise execution may become difficult to impossible.
A few weeks ago I showed how weak bounces have a tendency to quickly roll right back over. The good news is Tuesday’s bounce was far from weak. Tonight I decided to show a similar study examining strong bounces after a sharp move to new lows:
As you can see there tends to be an immediate and lasting edge when the bounce is sharp like we saw on Tuesday. There was a weak spot with Tuesday’s bounce, though – volume. It came in quite a bit lighter than Monday. Adding this filter changes the results to look like this:
Instances are a bit low, and many of them aren’t very comparable to current conditions. There’s a big difference between a rebound from a 2% drop and a rebound from an 8% drop. Therefore, I’d suggest the appropriate thing to do with this study is keep it filed for future reference. Then perhaps review some of the charts I posted last night.
The S&P 500 today lost 8.7%. That wasn’t the worst of it. The Nasdaq 100 lost about 10.5% and the banking index (BKX) lost 20%. For the S&P 500 there has only been 1 day that has been worse – 10/19/87 – the crash of ’87. On October 26, 1987 the S&P dropped 8.3%, which was close. Some other memorable drops since then would include 10/27/97 (-6.9%), 8/31/98 (-6.8%), and 9/17/01 (-4.9%). This was about 2% worse than any of those.
Using the Dow, I was able to look at similar drops back to 1920. Below are charts of all the times the Dow lost 8.0% or more in one day.
1987
1932 and 1987 were the only instances that were near a low.
In no case was a V-bottom like ’97, ’98, or ’01 formed. A sharp bounce was followed by either sideways or downward movement.
A sharp bounce occurred within 3 days in all cases.
1932 was the only time the day of the big drop came after an extended decline. In contrast, the crashes of 1929 and 1987 happened as a breakdown from a topping pattern.
By measuring the absolute gap I did not factor direction into the equation. A large gap up is just as “reactive” as a large gap down. The 10-day average absolute gap is currently about 3 times as large as the 100-day average absolute gap. It peaked at nearly 3.5 times on the 19th. The only other time since the inception of the SPY that this ratio has been this high is after 9/11/2001. The study below looks at 20-day performance after different multiples have been achieved.
I looked at gaps lower of 1% or more since the bear market began last October. There have been 24 of them. Below are a few quick stats.
12 of 24 filled made it back to the previous day’s close at some point during the day.
14 of 24 finished higher than the open.
19 broke above the high of the 1st half hour. 10 made higher gains. 9 closed lower than the breakout. The average gain from breakout to close was 1.6%. The average loss breakout to close was 1.2%.
19 also broke below the 1st half hour of trading. 10 of them finished above the breakdown point and 9 below. The average gain of the risers was 1% and the average loss of the decliners form the breakdown point was 1.5%.
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Also, Thursday was a follow through day for the market. Traders may want to review some of the FTD research over the weekend, including short-term implications.