The weather, that is, not the stock market. DFW has had several weeks now of triple digit heat indexes and I tell you what, walking outside in a 30 mph hot wind will dry you out in no time flat.
I wish the market had been hot these past three weeks but I’d be lying to you if I said it was. The equity indexes are in the midst of their longest pullback since February – March 2011. Are they close to bottoming? That remains to be seen.
Although the market closed higher today, volume was weak. The Dow Industrials gained 76 points to close at 12,080.38. The S&P 500 Index rose .54% and the Nasdaq Composite was up .50%. Bond yields rose slightly. Oil, gold, and silver all made modest gains.
ETFs were very quiet today. URE, the levered real estate ETF, rose 2.21%. TNA, the 3x levered small cap bull ETF, rose 2.07% and is fighting to hold onto its 200-day SMA. XRT, the retail ETF, was up 2.02% on a little better than average daily volume. Please click on the symbols for details..
Bond yields have been dropping since mid-April. TLT, the 20+ Year Treasury Bond ETF, moves higher when yields drop. Dave Landry’s Bow-Tie indicator picked up the downturn in yields back in mid-April. The chart below shows the upside bow-tie crossover and the entry point is highlighted with a yellow circle. Please click on the chart to make it full-screen:
The bow-tie involves three moving averages: the 10-bar SMA, the 20-bar EMA, and the 30-bar EMA. The moving averages should converge and spread out again, transitioning from a proper downtrend order (10-SMA < 20-EMA < 30-EMA) to a proper uptrend order (10-SMA > 20-EMA > 30-EMA). According to Landry, ideally this should happen over a period of three to four days. The creates the appearance of a bow-tie in the ETF.
Here are the entry rules for a long trade (short sales are reversed):
1. The moving averages transition from proper downtrend order to proper uptrend order.
2. The ETF must make a lower low and a lower high.
3. Once #2 has happened, go long above the high of #2 until filled. If the ETF starts trading below its 20- or 30-day EMA before you’re filled, reevaluate the trade and consider standing aside.
Landry suggests that long trades be held until the ETF starts trading back to or below its 20- or 30-day EMA. That doesn’t mean you should automatically sell there, although taking partial profits is never a bad idea. Use other technical indicators to confirm the trend is changing. If you’re still in the ETF and the moving averages reverse to a proper downtrend order, however, exit the trade.
My personal preference is to hold the trade as long as the moving averages don’t reverse into the proper downtrend order. It’s okay to continue holding the trade if the 10-day SMA falls below the 20-day EMA, as long as the 10 and/or 20 are still above the 30-day EMA.
There’s no sign yet of a rise in rates but if the equity markets bottom out and start rising, it’s likely rates will rise.
The odds are improving for the stock market to make some sort of a rally attempt, or at least a push off of recent lows. SPY (S&P 500 Index ETF) has successfully held above its 200-day SMA and DIA (Dow Diamonds) has held well above its 200-day SMA, although QQQ (Nasdaq-100) is a little below.
A good indicator for judging market reversals is when the VIX hits its upper or lower Bollinger Band (“BB”) and then reverses. Developed by Mr. John Bollinger in the early 1980′s, the BBs are adaptive trading bands that consist of three lines drawn around a security – a high band, middle band, and low band. The middle band typically defaults to a 20-day SMA, although it can be made any value the user wants. The upper and lower bands are usually two standard deviations above and below the middle band. There are many, many different methods of interpreting the BBs and Mr. Bollinger offers classes around the world in its use.
When the VIX (or any security, for that matter) rises up to the upper BB it tends to pull back to the middle band and sometimes to the lower band. Remember the following rule of thumb: High VIX = High Fear = Lower stock prices. When the VIX hits the upper BB and pulls back, that tends to coincide with a bottom which is followed by rising stock prices:
You can see how every time since late January, when the VIX tags its upper BB, within a day or two the SPY bottoms out and rises. Sometimes the rise is substantial – like in late January and mid-March – and other times it’s minor – like in February and May. The VIX reversal today was the real deal, however – look at the size of today’s bearish engulfing bar. So does this guarantee an upside reversal to the stock market? There are no guarantees in this game but while the market never plays the same song twice, it frequently reuses the same notes. Whether that is the case again this time is something we will know in the fullness of time.