Dr. Duke's Blog
Do you know any trading coaches who publish the results of their trades daily? Dr. Duke posts the trading track records of his Flying With The Condor™, Conservative Income, Dr. Duke's Trading Group, and The No Hype Zone Newsletter services in the free downloads section of this web site. If you have questions about any of the trades, Ask Dr. Duke.
Don't Hide Under The Desk
- Written by Dr. Duke
I expected this market to be volatile and choppy leading up the election. But the weakness in the markets over the past two weeks has surprised me. Is this a harbinger of even more bearishness next week? Or will the market “get over this” and settle down quickly after the election?
I wouldn’t have predicted the wild market reaction to BREXIT or its rapid recovery just a couple of days later. The market’s reaction to the election results can’t be predicted either, although I am sure many will try. The key isn't predicting the move. Success in trading comes from managing the risk.
SPX closed today at $2085, down $3 and RUT closed at $1163, up $7. But the larger picture is much more dire. Since the most recent market peak on October 24th, SPX has declined 3%, while RUT and the NASDAQ Composite have dropped almost 5%. Will these declines continue or even accelerate next week?
If we draw the Bollinger bands on the SPX price chart, we will see that today’s close was the fourth successive close below the lower edge of the Bollinger bands. The Bollinger bands are drawn at two standard deviations around the 20 dma. We would expect about 95% of the data to be contained within the bands, and that generally holds true. It is common to watch stock or index prices oscillate within the bands, but when prices move outside the bands, they are usually pulled back within the bands in short order. The number of closes below the lower edge of the Bollinger bands during a correction is usually pretty small, typically three or four. The fact that we have already observed four lower closes this week might tempt us to think that we are close to “hitting bottom”. But this market perturbation may be unusual. We are setting every other record with this election. Why not in the market as well?
Stock market risk is very high as we go into this election. We can't predict who will win the election and we certainly can't predict the market's reaction to the election results. What we can do is manage the risk. I closed all of the positions in my Conservative Income service today. As my most conservative trading service, it makes sense to go entirely to cash in advance of the election. In my No Hype Zone newsletter, we closed our TSLA iron condor a couple of weeks ago for a nice 26% gain, but I have been reluctant to add any new positions in this market environment. My November iron condors in the Flying With The Condor™ service are over two standard deviations out of the money, so I may leave them open, but that judgment may change on Monday or Tuesday. The feared "black swan" moves of three and four standard deviations may be a very real possibility next week.
The easiest way to control your market risk is to simply go to cash. But you may have a large stock portfolio that would have significant tax liabilities triggered by selling. Hedging the portfolio with a few out of the money index put options is the answer. Use the option price calculator on your broker's web site to estimate the gains of those put options under a couple of "what if" scenarios. Based on the gains you project for the puts, you may estimate how many puts will be required to hold the losses in your portfolio to a reasonable level. Whatever you do, don't just sit and hope for the best. Take control. Manage the risk.
What Fed Meeting?
- Written by Dr. Duke
For the last several years, we have become accustomed to the market slowing and treading water as traders anticipate the upcoming FOMC meeting. But today is different. The Fed is meeting today and tomorrow, but no one is paying attention. All eyes are on the election next week and the latest scandals to erupt. My friends in Europe tell me that the everyone is glued to this Peyton Place saga (if you are old enough to remember Peyton Place).
Market behavior yesterday was unusual. Volatility rose, with the VIX moving over 17%, but the broad market averages were also rising most of the day - an unusual divergence. Normally we see volatility rise as the market declines. How should we interpret this anomaly?
Markets hate uncertainty, although options traders enjoy higher volatility, especially if you are selling premium. Many institutional traders are moving larger proportions of their portfolios to cash and are buying protection, as evidenced by the rising VIX. What should we lowly retail traders do? Personally, I am pursuing three lines of action:
1) A larger proportion of my accounts and client accounts are in cash. As profitable positions were closed, we didn't enter new positions.
2) I am selling weekly options in my more conservative accounts. As I close those positions this Friday, I will stay in cash until after the election.
3) I will be closing my November iron condors on the broad market indices if the spreads are less than two standard deviations out of the money.
I expect the market will be quite volatile after the election, but I think it will settle reasonably quickly. The model in my mind is the reaction to Brexit - surprise followed by the sentiment, "maybe the sky isn't falling after all".
As I write this article, the market futures are mildly positive, looking much like yesterday when the market stayed in positive territory most of the day, but then slowly lost ground to close unchanged. The sideways, choppy price action of the past several weeks may continue to be the norm as we move closer to this election. The sky isn't falling, but it may be quite stormy before it clears.
- Written by Dr. Duke
The Standard and Poors 500 Index (SPX) closed today at $2133, unchanged after a wild ride higher in the morning; but all of those gains were lost by the close this afternoon. SPX opened the week at $2160, so the net price action was lower on the week. SPX flirted with the lows from early September yesterday, but recovered to close at $2133. The September low at $2120 is the new lower edge of the sideways trading channel, with an upper edge at $2195, set back in August.
The markets have been characterized by this sideways churning since mid-July. Market analysts are unanimous in one aspect – they are all nervous. Some blame the Fed and their concern about the prospect of higher interest rates. Some blame the presidential election, and one can easily find traders who are concerned about the prospects of either candidate winning. A Wall Street Journal survey of economists was published today, and gave a 60% probability of a recession within the next four years. That report was featured on all of the financial networks. What all of these analysts have in common is a high level of anxiety, and the looming specter of another market crash is always on traders minds during the month of October. We are seeing the net effects of all of these worries in the churning, directionless market.
The Russell 2000 Index (RUT) closed today at $1212, down $3 today and down about $27 or 2% for the week. RUT’s close today is essentially at its low when the market traded lower in early September. The question is whether RUT will break down through $1210 next week or continue to trade within the channel of $1210 to $1265. Russell has traded more weakly than SPX and the NASDAQ Composite all year. RUT has not even approached its high from 2015 at $1296. RUT’s price action continues to communicate a bearish signal.
I summarized the market last week as:
Nothing much has changed in this market for several months now. The GDP growth rate is minimal, corporate earnings are mediocre and the forward guidance has been bleak. The uncertainties surrounding the presidential election are piled on top to collectively hold the bulls in check. But the near zero interest rates are holding the bears in check. The result is a choppy, nervous, sideways market.
Nothing has really changed. If anything, traders are even more nervous. Be careful. This may be a good time to take a break if you can’t watch this market closely.
- Written by Dr. Duke
October is well known for its large number of severe market crashes, from the famous crash of 1929 that ushered in the great depression to the financial meltdown of 2008. Maybe the hobgoblin of market crashes has the bulls pulling in their horns (too many metaphors). SPX closed today at $2154, down $7, and ending the week down ten dollars. RUT didn't fare any better, closing down at $1237, losing $14 for the week. Volatility rose a bit today, with the VIX rising about seven tenths of a point to close at 13.5%.
SPX has traded sideways for about three months now, with a brief pullback on September 9th, followed by a quick recovery. But now we are firmly back in the sideways trading channel. If you plot the Bollinger bands on the SPX, you will see that the price has stayed close to the center of the bands for over two weeks.
Whereas SPX and the NASDAQ Composite indices have set new all-time highs this year, the Russell 2000 Index (RUT) has failed to reach the high it set at $1296 in the summer of 2015. This is a bearish sign because the high beta stocks of the Russell have normally led bull markets higher.
It is interesting that the jobs report this morning didn't move this market much either way. I thought a weak report, which we received, would enthuse the bulls since they would expect weak jobs numbers to hold the Fed's interest rate hikes at bay for a while longer.
This sideways market is ideal for our iron condor positions in the Flying With The Condor™ service. Our October iron condor on SPX is up 23% and the November position stands at a net gain of 9%. I will probably close the October position next week and open December.
Nothing much has changed in this market for several months now. The GDP growth rate is minimal, corporate earnings are mediocre and the forward guidance has been bleak. The uncertainties surrounding the presidential election are piled on top to collectively hold the bulls in check. But the near zero interest rates are holding the bears in check. The result is a choppy, nervous, sideways market. We may be stuck here for a while.
The Trend Is Higher, For Now
- Written by Dr. Duke
SPX opened this morning at $2162, traded down to $2152, but then rebounded to close at $2171, up $11 on the day. Candlestick enthusiasts will note this as a long lower shadow, a classic clue that the bulls are strong, i.e., they saw that intraday low on SPX as a bargain and starting buying, driving the price higher. And this was on higher trading volume, with 2.2 billion shares of the S&P 500 trading today. Trading volume was up 16% on the NYSE and was 4% higher on NASDAQ.
But there was another significant clue of bullish strength today. The durable goods orders report came out today for August and was dead flat, 0.0% change. July was up 3.6%. The durable goods report is one of the fundamental measures of U.S. economic strength, and this was a terrible report. But the market shrugged it off and traded higher. Strong bull markets ignore bad news... until they don't.
Tomorrow brings the final estimate of the second quarter GDP growth rate. The last estimate was a paltry +1%, annualized. If the report tomorrow continues on that weak line, it will be a another test for the bulls.
In the meantime, the recent market behavior has been nearly ideal for delta neutral traders. My September SPX iron condor closed at a 16% gain. The SPX condor for October is up 21% and the November position is already up 6%, even though it has only been open for a couple of weeks.
The market clearly has a bullish bias, but be careful. It remains a nervous market.
Does This Market Make Sense?
- Written by Dr. Duke
Last Friday, SPX fell out of bed and lost over $53 or 2.4%. You might think that a negative GDP number or something equally disturbing had been reported. But nothing that logical occurred. A couple of the Fed governors had suggested in interviews that the economy might be sufficiently strong for another interest rate hike in the near future. If the Fed believes the economy has recovered sufficiently to handle higher interest rates, that should be good news. But traders hit the sell button. Does that make sense? I don't think so. But maybe I shouldn't be trying to view this market action so rationally.
Whether you have been trading the markets for the past 5 years or 30 years, you have never seen near zero interest rates at all, much less for several years in succession. So traders are in uncharted territory. Normally, the younger staff in the trading firm turn to the older staff and hear comments like, "Don't be too concerned, this looks similar to the markets in late 1987 after the big crash in October. Within a year the markets had recovered all of those losses." Today's market is unique. No one has seen this situation before. Consequently, market observers are nervous and tend to sell at the slightest sign of trouble. Consider the recent BREXIT panic as an example. The BREXIT vote scared traders and the markets sold off quickly. The fact that the effects of Britain leaving the European Union would not be realized for two years or more was known and well publicized, but it didn't matter. Traders were scared and hit the sell button. But this has happened many times over the past few years. Those same nervous traders have learned to "buy the dip". Thus we have the so-called "V-bottoms" that have been a common characteristic of recent markets. The BREXIT panic caused a loss on the S&P 500 of 5.3% in only two trading sessions; within four trading sessions, that entire loss was recovered, and the market continued to trade higher yet for about two weeks. Traders are nervous in this "uncharted territory" and sell upon the least rumor or speculation. But we are all well aware that we have been in a strong bull market, so we quickly "go all in" whenever we see market prices start to rise - hence, we buy the dip.
After losing over 2% last Friday, SPX recovered much of that loss on Monday, but then traded back down on Tuesday. SPX closed today at $2147, not quite back to last Thursday's close at $2181, but close enough that volatility declined almost two points today. What is a trader to do? Psychotherapy? Antidepressants?
As many of you know, I trade iron condors on the broad market indices every month. Before the market opened last Friday, I was planning to sell my November SPX iron condor. But all of the red ink stopped me. As I listened to all of the talking heads interview the gurus predicting "the sky is falling", I couldn't get too excited about this decline. As the day wore on, the indices started to stabilize and I decided to sell the November SPX 1890/1900 put spreads. As the markets rebounded on Monday, I sold the November SPX 1940/1950 put spreads. At today's close, the short puts at 1900 and 1950 are 1.7 and 1.3 standard deviations out of the money. This corresponds to probabilities of these spreads expiring worthless of 96% and 92%, respectively. Don't misunderstand. I was still focused on risk management. I sold only half of my normal capital allocation on Friday and was prepared to buy it back on Monday if was wrong. But, instead, I sold the balance on Monday at a higher index price.
This market remains volatile and unpredictable, so stay cautious and manage your risk carefully. However, rational analysis of market behavior remains a useful discipline.
The Bears Take Charge
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) has been trapped in a sideways trading channel for the past couple of months. SPX dramatically broke out of that channel on Friday, closing at $2128, down $53 or 2.4%. SPX gapped lower Friday morning, opening at $2169, and didn’t even pause as it broke the 50 day moving average (dma) and then took out long-term support at $2160. Even more ominously, all three major broad based indices, SPX, RUT and the NASDAQ Composite, closed at their intraday lows. This type of close is very bearish; go back and study the charts preceding the August flash crash from last year.
What triggered this breakout? The best answer appears to be recent interviews with two FOMC members suggesting a rate hike may come as soon as the Fed meeting later this month. This certainly isn’t the first time that the market has seemed to freak out over a quarter point interest rate move. To my mind, it doesn’t make any more sense this time than it has previously. Interest rates are going to remain below one percent for the balance of 2016 in all plausible scenarios. Would that increase in interest rates throw cold water on business expansion plans? I seriously doubt it. For that reason, I think this correction will be brief, but that doesn’t mean we should just sit on our hands.
On the other hand, perhaps weak economic data, such as one percent GDP growth, and a string of five consecutive quarters of declining corporate earnings, are beginning to weigh on the market. The Russell 2000 Index (RUT) closed Friday at $1219, down $39 or 3.1%. RUT has been trading higher since the BREXIT panic, so Friday’s large move wasn’t a breakout from a sideways channel as it was with SPX. RUT closed on Friday near a solid support level around $1220. RUT remains as the only major market index that has failed to make new all-time highs over the past couple of months. The lagging behavior of RUT as other indices traded higher suggested some restraint on the part of the bulls. But RUT’s smaller drop on Friday also suggests that the bearish action has not fully impacted the small caps as yet. If we see a solid break of the 50 dma on Monday, that would underscore the bearish move.
Volatility spiked much higher on Friday, with the VIX closing at 17.5%, up five points in one day. Those of you speculating with VIX calls are celebrating this weekend.
Given the backdrop of weak GDP growth and declining corporate earnings, a bearish move certainly shouldn’t be surprising. The surprise is the suddenness of the move and the move being attributed to the possibility of the Fed increasing interest rates at the meeting this month. Perhaps this is just one more illustration of a nervous market that can turn on a dime in either direction, e.g., the BREXIT panic resulting in a large price decline for only two days, followed by a prolonged bullish run higher.
The Federal Reserve has historically maintained a strong non-political posture. I don’t think that is likely to change, so the prospect of the FOMC raising interest rates on September 21st, less than two months ahead of the presidential election, seems very unlikely. Thus, I would not expect Friday’s significant price drop to continue on Monday, which is why I held my positions on Friday, and even sold some far OTM SPX put spreads. But if this decline continues on Monday, I will be aggressively closing and/or hedging positions.
Trapped In A Sideways Channel
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) closed today at $2180, up $9. SPX has been trading in a tight channel from $2157 up to $2194 over the past seven weeks. This channel has been reinforced over the past couple of weeks by the shadows of the candlesticks. Pull up a chart of SPX and observe how the upper and lower candlestick shadows define support and resistance.
The bulls and the bears are in a closely matched tug of war. The bulls are being held in check by poor economic data, such as one percent GDP growth, and a string of five consecutive quarters of declining corporate earnings. On the other hand, the bears can’t manage to take control and drive the market lower primarily because the FOMC has left interest rates at record lows.
Trading volume in the S&P 500 continues to run below average with neither the bulls nor the bears able to sustain a strong push. SPX trading volume has only increased enough to touch the 50-day moving average (dma) a couple of times during August.
The Russell 2000 Index (RUT) price chart presents a different picture from SPX in two key respects. First, RUT has been trading higher rather consistently since the BREXIT panic. Today’s close at $1252, up $12, is the high for RUT for 2016. But the second difference between RUT and SPX is that SPX has set several
all-time highs over the past few weeks. RUT remains 4% below its high from last year at $1296.
This lagging behavior of RUT suggests some restraint on the part of the bulls. They are not sufficiently confident to “go all in” and strongly buy the small cap stocks. But the persistent trending of RUT higher as SPX is trapped in a sideways channel may suggest that the bulls are gaining confidence.
GDP growth rates of one percent or less are on the brink of recession. At best, we have a very lackluster economic environment. When I add five consecutive quarters of declining corporate earnings, I am seriously concerned about our economy. But then I look at the market prices. How long can this continue?
Has the Post-BREXIT Run Ended?
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) set a new all-time high on August 15th and tried to reach that number again on August 23rd, but it has faltered since then. Janet Yellen spoke at the Jackson Hole economic conference at 10 am ET this morning, and SPX made its intraday high a few minutes later. But then the party ended. Traders decided another interest rate hike is coming and sold off. SPX reached a low around 2:30 pm ET but then recovered a bit to close at $2169, down $3. The second quarter GDP growth numbers, announced earlier this morning, with an annualized growth rate of 1.1%, probably didn’t help. That is pretty weak. FACTSET released the final earning results for the S&P 500 for the second quarter, down 3.2%. This is the fifth consecutive quarter of earnings declines. This is the first time we have seen a five quarter string of declines since 2008-2009.
However, SPX is holding up rather well. $2160 has set up as a solid support level and that is where SPX bounced today. If we break $2160, the next level to watch is the 50-day moving average (dma) at $2144. Trading volume in the S&P 500 companies has run below the 50 dma since August 8th. This market is certainly out of steam, but that doesn’t necessarily mean it is going over the cliff. SPX has been very resistant to the bearish arguments.
The Russell 2000 Index (RUT) just traded modestly higher this week, but closed at $1238 today, down two dollars. RUT was not able to match its highs from last year during this strong post-BREXIT run, a bearish sign.
After trading near 2016 lows last week, the SPX volatility Index (VIX) moved higher this week, opening Monday at 12.5% and closing today at 13.7%. Perhaps more significantly, VIX moved as high as 15% earlier today. I would guess the bounce of SPX off support at $2160 calmed some nerves.
A couple of weeks ago, I offered two possible driving forces behind the bullish post-BREXIT market:
1) Traders are buying with renewed confidence that the Fed won't raise interest rates before the end of the year.
2) We may be seeing the effects of global cash flows seeking a safe haven in our stock market. The global economy is slowing and, even though the U.S. economic data are mediocre at best, we are looking better than most.
With the market’s reaction to Yellen’s comments today, perhaps we are left with the “best house in the bad neighborhood” theory. It may be significant that the market did not trade lower this morning after the weak GDP growth numbers. Poor economic data continue to be ignored by this market. It appears to be primarily Fed driven, which would argue that a pull back won’t come until the FOMC actually raises interest rates. But will Yellen and company raise rates before the election? I doubt it. They don’t want to be seen as adding fuel to the fire for either side’s arguments.
Be cautious. This is a nervous market. As evidence, look at the three point intraday range of the VIX today.
Another One Bites the Dust
- Written by Dr. Duke
The title of this song from one of my favorite bands, Queen, came to mind today as I thought about today's price action. This bull market, that by all measures should not be continuing higher, did just that again today. SPX tacked on another six points to close at $2190, while RUT spurted higher by $12 to close at $1242. And the NASDAQ Composite did not want to be outdone, gapping open this morning and gaining $29 to close at another all-time high at $5262. All-time highs are becoming passe.
Many valuation measures, such as the price to earnings ratio and the average dividend yield of the S&P 500, suggest a pricey market. We are nearing the end of the second quarter earnings announcement cycle, and earnings have declined once again on a year over year basis. When you think about it, the only way the P/E for the S&P 500 may continue to rise is that share prices are rising faster than earnings are declining. At its most fundamental level, stocks are priced on the value of the discounted cash flow of the projected earnings. Yet prices continue higher as earnings decline.
Don't misunderstand. I am not trying to say the market has it all wrong. The ultimate arbiter is the market price. But that brings me back to the title, Another One Bites the Dust. In this context, another bear covers his shorts. Where does it end? No one knows. But it is clear that we are increasingly on thin ice.
So what should we be doing in this market? I don't presume to have all the answers, but my trading boils down to a few bullet points:
- I am continuing to play bullish stocks as they trade higher. But I am using diagonal call spreads to give myself some safety margin on the downside, just in case the market pulls back one of these days.
- I am closing profitable trades early to lock in gains. If I can bank 70-75% of the potential gains on a trade, I take it.
- As I position my non-directional trades, I am allowing for more safety margin on the up side. I am not betting against the bull.
- I am as nervous as a long tailed cat in a room full of rocking chairs.
Make money while you can, but be careful out there.