Volatility in Vogue
Since my last writing, stocks have undergone the second correction of 2007. Both spurred on by the insidious credit crisis that just won't go away. In the last month, two of the most preeminent players in the mortgage arena, Fannie Mae and Freddie Mac, have seen their share price drop about 60%. These types of losses are staggering, and unprecedented for the stocks of this ilk (blue chips). In the past, these securities were deemed appropriate for placement, even in the most "conservative" of portfolios. Unfortunately, now they've become widow makers for many shareholders.
On Tuesday of this week, the Federal Reserve released their forecast on the economy, along with the minutes of the October meeting. In the statement, they expect the economy to slow and inflation to moderate. Also noteworthy, is the fact that they are finally starting to pay close attention to the effects the housing slump is having on consumer spending. The initial reaction by the markets was negative as hopes for further rate cuts faded, but by the close the major indices regained their footing and closed higher for the day.
In my opinion, I believe Tuesday was a pivotal day for the market in the short-term. There are several reasons for this: First, the sentiment readings are indicating extreme put-buying by the public, as measured by the ISEE index (persistent readings below 100). This was further corroborated by the sense of panic I detected when talking to investors that day. Secondly, some financial stocks formed climactic selling patterns. In particular, Countywide Financial (CFC), which has been in the maelstrom of the mortgage melt down and as such is strongly linked to this crisis. In the 5-minute chart below, there are classic signs of capitulation: decreasing volume in the early decline, an acceleration to the downside, accompanied with a surge in volume and finally followed by a huge price reversal.
The final piece in my reasoning comes from the fact that I had to go back to the 2000-2001 bear market to find the market as oversold as it is presently. The only caveat here is that there is the possibility- albeit small - that the market crashes. The one thing I've learned in this business is to "never say never".
In the last newsletter, I wrote about the positive seasonal tendency the market tends to exhibit during the last two months of the year. Obviously, this year – at least up until now - this has not panned out. For the month of November, the bears are in control thus far, but there's still December and a Fed meeting on the docket. This gives the bulls something to hang their hat on, if they're to hold on to the gains for the year.
In our usual fashion, we'll shift our attention to the charts. The first illustration is that of the weekly chart of the ER2 below. In this instance we have to go back fully one year to see where the next support area is. If the ER2 holds these lows, then there's a possible double bottom forming. If on the other hand it breaks lower, then the next support is roughly 35 points lower.
The next chart we'll peruse is the hourly chart of the ER2. What we see here is a clearly defined down trend and a resistance level at 759.20. In order to change this trend in any meaningful way, this level has to be regained by the buyers.
The last chart we'll look at is that of the Vix or volatility index (below), also referred to as the "investor fear gauge". The Vix measures implied volatility going out 30 days on the S&P 500. As the market declines, the demand for put options increases, hence, premiums go up (the price paid for portfolio protection) and consequently the Vix rises. At the point investor fear reaches a fever pitch, the Vix spikes, which in the past has been a reliable marker of market bottoms. The tricky part is figuring out at what levels anxiety turns into panic. Usually, a high percentage move in the Vix will do the trick.
In Summary: The Volatility in the market remains high and I don't expect it to change anytime soon. This is great news for traders as opportunity abounds. One of the refrains many new traders have is the fear of big market moves. What I tell my students is that market movement is what's needed to make money, as long as rigid risk management is applied. The market is extremely oversold here and I believe a relief rally is forthcoming. That being said, the worst possible scenario is something that I never discount. If you're long stocks, make sure you have your stops in place-just in case disaster strikes.
So until next time, I hope everyone has a great holiday.
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the