2.16.12 – Higher And Higher

Strong economic date sent the S&P 500 Index to a 9-month high, gaining 1.10% today.  The Dow Industrials rose 123 points to close at 12,904.08 while the Nasapple (err…Nasdaq) Composite was up 1.51%.  Oil prices continue to climb, with March crude prices closing above $102/barrel.

GAZ, the natural gas ETN, continues to bubble by gaining 6.27%.  TNA, the 3x leveraged Small Cap Bull ETF, was up 5.78%.  Yesterday it pulled back to its 20-day EMA and rallied today.  URA, the uranium ETF, was up 4.9% on almost 200% of average daily volume but so far its been unable to get back above its 200-day SMA – the SMA has been resistance for the last three weeks.  UYM, the leveraged basic materials ETF, rose 3.81%.  Please click on the symbols for details.

On Wednesday I discussed how XLB, the basic industries SPDR, signaled a second buy using the Connors/Alvarez RSI 25 strategy.  The initial buy was last Friday when the 4-day RSI closed below 25 and the second buy was Wednesday when the RSI closed below 20.  XLB exited today for a .89% gain.  Nothing to sneeze at for a five day trade but don’t assume it will work this well again because past performance is no guarantee of future results.

On Monday I noted the following: “What happens when the the VIX reaches the upper or lower Bollinger Band (BB) and on a pullback or throwback to the middle BB, fails to close through it?  As a rule of thumb the VIX tends to move back in the direction of the upper or lower BB it tagged.”  That happened yesterday, as seen in the chart below.  You can make it full-screen by clicking on it:

Last Friday the VIX hit its upper BB and on Monday it traded through but closed above the middle BB.  On Tuesday it touched the upper BB again as volatility rose intraday but closed well below.  Yesterday’s action sent the VIX to close above the upper BB and today’s strong up move sent the VIX much lower.  Notably, it’s still above the middle BB.

The steady rise in the equity markets the past two months has been marked by declining volatility.  Historical Volatility (HV) tends to be mean reverting.  HV is the standard deviation of day-to-day price changes expressed as an annual percentage.  If you know how much an asset has fluctuated in the past, you can use this information as a gauge for how much it is likely to fluctuate in the future.

As a rule of thumb, ETFs with higher HV readings have fluctuated more in the past than ETFs with lower HV readings.  Furthermore, those assets with higher HV readings will likely fluctuate more in the future than assets with lower HV readings.  You can find historic volatility calculators on the web.  What you want to find is ETFs with higher historic volatility.

Just knowing an ETF has a high historic volatility isn’t a timing tool, however.  Larry Connors developed the methodology of using the ratio of a shorter-term HV (six-day) divided by the longer-term HV (100-day).  When the reading falls below 50%, volatility is prone to revert back to its mean so you can expect to see a sharp price move.  The time to buy is when the HV ratio rises back above 50% (.50).

Although XLB exited the RSI 25 swing trade signal on today’s close it also set off a buy signal using the HV ratio.  Since late November there have been three previous buy signals (blue up arrows) that exhibited sharp price rallies following volatility reverting to the mean:

The horizontal blue line is set at 50% (.50).  The HV ratio for XLB rose today to 56% (.56) after trading well below 50% since early January.  Please keep in mind that that the HV Ratio below .50 does not predict direction, it predicts that large moves often occur out of low volatility situations. For example, with XLB the HV ratio rise back above 50% in July of last year was followed by a multi-month, 30% price decline.

If you’re using a screening platform like TradeStation you can program it to alert you when the HV ratio rises back above 50%.  The HV Ratio is another implement in our toolbox we can use to squeeze a buck or three out of the market.  I encourage you to research the HV Ratio.

I’ll likely be out tomorrow afternoon so enjoy your three-day weekend.



About Dave

David Steckler enjoyed 24+ years of experience as an investment counselor and portfolio manager before retiring. A former professor at Lindenwood University in Missouri, he also was a member and past president of the American Association of Professional Technical Analysts (AAPTA), and a member of the Market Technicians Association (MTA).
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