Archives 2022

A liquidity cascade and negative feedback loop can take the market significantly lower. I will do my best to explain it. It involves the influence of the options market, which has grown so large in the past few years that we have to consider it in our algorithms.

I discuss and identify the Weekly Expected Moves week to week respecting weekly options. And you see how influential they are most of the time. But options have an even more significant impact when considering Gamma and Delta hedging. Dealers on the other side of puts and calls have to hedge. At certain levels of Gamma and Delta, they have to hedge a lot and frequently.

When volatility is this high, it is nearly impossible for dealers to keep up. Accordingly, they step away from the market, and liquidity evaporates, making the problem worse.

We had the positive benefit of Gamma in the bull market phase. We would see tight, persistent rallies. These were positive Gamma squeezes. The more traders bought calls, the more the dealers had to hedge by buying the underlying stock or index or futures. The hedging created a positive feedback loop.

Now we are seeing the opposite. The more investors buy puts; the more dealers have to sell the underlying stock or index or sell futures. This hedging creates a negative Gamma squeeze with tight sell patterns.

ETFs and indexing, in general, are related problems. It does not matter how good your stock is; it suffers when investors dump ETFs and indexes. Options leverage only exaggerates the problem.

Most of the Gamma is sitting at 4000 on the S&P 500 index. As the market approaches that or other significant Gamma levels, dealers may have to unwind their positions as investors cover their puts, and the Gamma squeeze reverses to positive.

I will mention something one of my mentors once told me. The best investments sometimes make you sick to your stomach because the fear is high. We call it the puke point. As Russia makes its full-blown Ukraine invasion and given most of the other Fed risks are known, we may deploy some capital into the capitulation.

Fasten your seatbelts, and let’s see how it goes. It is going to be a long night.

A.F. Thornton

We have a full retest of the January low underway. Not only is the S&P 500 going to close on its low. It will close on or near its critical retest level just above 4200 – leaving us hanging. The NASDAQ 100 will close below its January low. One could suggest that where the NASDAQ 100 goes, the S&P 500 will follow.

The S&P 500 has been one-time-framing lower for five sessions in a row. The slow, consistent, and somewhat demolishing behavior reminds me of 2000 and 2007, but more on that later. I have watched the order book dry up several times today, meaning there is little or no liquidity, at least as it relates to the order book.

The U.S. Intelligence community has informed Ukraine that a full-scale invasion will be underway in 24 to 48 hours. A full-scale invasion could precipitate a full-on market crash into the 3600 level.

I will expand on all this tonight with a short video and discussion. The WEM low at 4229 did provide some brief support.

I am beyond thankful that our strategies are in cash. The Navigator Algorithm is an extraordinary tool.

A.F. Thornton

Day Traders – futures are higher this morning but still inside yesterday’s range. As traders speculate on their impact, global headlines continue to drive the price action. The Fed’s hawkish stance on interest rates could change with global strife and its effect on consumer, business, and investor psychology. The January low is still secure at this writing,

Premarket indications are not showing imbalance in either direction at the moment. Trade later rather than earlier. I am mindful of the larger “h” pattern, but it is hard to peg a bull/bear level today, given yesterday’s wide range. Watch where the value area develops in today’s session as it may provide a clue to further direction.

The 4300 level filled in with positions yesterday and is now the Key Gamma Strike on the board (down from 4400). We see 4200 as the Put Wall, down from 4300. Lower Gamma Strikes speak to a general trend of the options market accepting and repositioning around lower prices. Overhead resistance is at 4350, then 4400. Support lies at 4300, then 4265.

A.F Thornton

Swing Traders

The Navigator Algorithms remain in cash. While today’s action did not compel us to deploy some money for a swing trade, the market behaved as anticipated in the weekly forecast. The S&P 500 held above the January low, an impressive feat in light of all the distressing global news on Russia and Ukraine. We will deploy cash if the low holds and price pivots.

It is explainable if the low holds and forms the bottom of a trading range here. The unexpected price action may reflect the conflict between global tensions and hawkish Fed policy. Consumer and investor pessimism could mute spending and growth, tamping down inflation. The results could help do the Fed’s job for them.

But there is no modern precedence for the current situation, and inflation could persist, especially for energy prices. So we need to be very technical and accurate about any turn higher. Putin’s limited invasion expanding to the rest of Ukraine could be a catalyst to breach the January low.

Nevertheless, be on alert for an entry tomorrow. Today’s price bar finished in the middle of the range. We need some upside follow-through to trigger a buy signal. We should know if the retest is successful in the next few sessions. For now, so far, so good.

Day Traders

The market rallied initially, then rolled over into a negative gamma spiral reaching the lower support line at 4270 mentioned this morning. A short-covering rally kicked in on positive delta trades coinciding with the 4270 level. The rally faded as it ran out of short-covering fuel, and futures finished in the middle of the range near 4300. Bears remained in control most of this day.

With the daily candle ending as a doji, the market can still go either way tomorrow. But thus far, the market held the January low on a lot of bad news. The trading was slow at times, indicating that the market fell due to the absence of buyers rather than aggressive sellers.

I will update all critical levels in the morning, but 4250 is the ideal level to hold if you look back across the past few years’ price action. Tomorrow’s action should be much like today’s – characterized by large directional swings.

We’re holding 4400 as major overhead resistance and see today’s test of 4270 as unlocking a step lower to test 4250 and 4200. Acceptance below 4200 pulls the rug out from under the market, opening up a measured move to 3600. The Gamma wall at 4000 is extensive and could stop any freight train before it reaches 3600.

A.F. Thornton

The S&P 500 first rallied to last night’s Globex high at 4377 but rolled over short of the goal at 4358. Though it filled a small gap, the market came back down through the open. Both actions showed weakness, and now a retest of the January low is underway.

The market is running into buy orders around the 4270 support level mentioned this morning. This level connects a trend line from the Covid Crash March 2020 low through the January low. Absent a flip from that line, a reversal pattern on the hourly regular session chart projects a full retest of the low around 4200. If all other measures confirmed it, it would make sense to buy the retest in a bull market.

Let’s see how it goes.

A.F. Thornton

I wonder what it must have been like in the 1930s between the great wars. A minor skirmish here and there. This land is my land. There were weak and strong leaders. Then all hell breaks loose, and it is World War II. What scares me is that human nature doesn’t change, even in these modern times.

My mother told me they had to leave their lights off at night so that their town in Vermont was invisible from the air. The government rationed everything from rubber tires to meat. The Russia / Ukraine skirmish wouldn’t bother me so much, but all the great wars came out of Fourth Turnings, just like the one we are experiencing now. At the moment, the West looks fat, spoiled, weak, and feckless. How “woke” is Putin and his army? How “woke” is Xi and his army?

As with Friday’s forecast, geopolitical headlines are taking center stage at the moment. The significant negative Gamma and elevated implied volatility exacerbate the headline impact.

Absent the successful overnight retest of the January low; I would see little reason for “risk-on” behavior. A large rally could be challenging without clarity on interest rates at the FOMC meeting on March 15th. But the market is oversold, and the trading range bottom could be in place. Keep the possibility in mind.

There will be bullish momentum and breadth divergences on the low today if we hold overnight levels, especially on the NASDAQ 100, as it reached new price lows overnight.

Due to the Russia/Ukraine situation, or perhaps the fact that the rest of the world traded futures yesterday while our exchanges were closed, we have a 140 point overnight range. I don’t need to tell you that it is vast.

Notably, the S&P 500 Futures did not get to the January low at 4213. The NASDAQ 100 Futures was the only index that briefly violated its January low, but they also brought it back. I view that as bullish in the circumstances.

The overnight range is not only large, we will open in the middle. I would advise “wait and see” mode – there is nothing to guide us for the open.

Given the market’s resiliency, I would stay slightly bullish above Friday’s low at 4321 up to resistance at 4400. Support is at 4300, then 4270. Freefall starts below the overnight low at 4250. Here are the current Gamma levels, with support and resistance in the valleys. Note the Gamma around 4000 – it is considerable. From an options perspective, it would take a lot of bear conviction to punch through that level.

My order flow screens show a lot of sell limit orders around 4375 this morning and only a few buys around 4250. That can certainly change and doesn’t include market orders, but the market typically goes to liquidity. So I would be careful holding longs at the level.

I marked all nearby key levels on my 15-minute screen below. The screen is noisy, but I typically day trade from a five-minute chart that spreads them out:

Ask yourself this question today. What is it that the market does not know at this juncture? Putin has invaded. Did oil prices move to new highs? No. Did gold prices move to new highs? No. Did the S&P 500 Index Futures make new lows? No. Are treasuries rallying or selling off this morning? They are selling off.

Also, note the “h” pattern on the S&P 500 and NASDAQ 100 indices. Some say the “h” stands for hell for the shorts.

The situation at hand looks like buy the rumor, sell the news behavior thus far. Make sure you review the macro picture from last night.

Don’t forget your stops with the volatility at hand, and good luck today.

A.F. Thornton

Current Thesis

I hope you are not sick of these charts. But they are the best visuals to support our thesis that the stock market is starting a generational correction into its long-term mean, assuming it doesn’t overshoot it. An intersection of multi-timeframe channel tops finally stopped the market in its tracks in January. The 100-year and all lesser channels peaked near S&P 500 Index 4800.

The current context distinguishes this pull-back from normal corrections. The stock market has tagged the 100-year top channel line only three times: 1929, 2000, and the recent January peak. These are “three-sigma” events, meaning they are way above normal statistical probabilities due to excess speculation. Commensurately, the prior occurrences resolved with greater than 50% corrections. BluPrint’s working thesis calls for an analogous correction in the coming weeks.

Fundamental overvaluation also supports regression to the long-term mean. Using the S&P 500 index as the proxy, the market peaked near 4800 or 195% of GDP. Professionals cap 120% of GDP as “Fair Value.” Readers can confirm the lofty market valuations using these additional resources.

Negative catalysts include high inflation, a related reversal in accommodative Fed policies, and a potential recession on the horizon. Also, global tensions are rising. The world has entered an era of secular upheaval, challenging the existing global order. Such disruptions are characteristic of “Fourth Turnings, ” which we have discussed before.

Projected Path and Targets

The stock market can travel along several different paths to correct its excesses. It can crash, zig-zag, move sideways, or combine all three. Crashes are low probability events – more often associated with unexpected circumstances.

The market is more likely to establish one or more trading ranges as it works its way to the mean. The mean can rise while the market moves sideways until they meet. The Dow Jones Industrial Average behavior from 1966 – 1984 is a good example of this kind of price behavior:

The ultimate target for this market may be the middle of the 100-year channel at 2400. That level is in the vicinity of the Covid-19 crash low. Without a full-on crash, 2400 (adjusted as it rises over time) is a longer-term target. It took the index three years to find the low of the 2000 Dot Com Bubble bear market, and six years more to retest it. The 1929 peak is infamous for its 90% correction and multi-year recovery time. The lower monthly channel line is the intermediate-term target. The level is 3600 or so (rising with the line). The level coincides with a more reasonable valuation at 100% of GDP, though lower GDP would lead to a lower ratio. Rumors persist that the Federal Reserve would begin to support stocks at the 3600-3700 level. A quick way to view and calculate this target is to take the January monthly candle as your breakout range. Double the candle for the measured move down if the market breaks below the candle. The 3600 target would be a 25% peak to trough correction. That would be in line with past cyclical bear markets. If the market reaches that target, we can reevaluate the lower target at 2400 – a 50% decline. 50% corrections tend to lead recessions, becoming secular bear markets.

Weekly Update 2/21/2022

Monthly Chart

The monthly chart is coming off the climax wedge into January’s top. The January low reached the wedge base, which was the measured move.

The monthly chart has two consecutive outside candles in January and Feburary. This is a breakout mode pattern with 50/50 odds. But breaking to new highs is difficult to imagine at the moment. The move to 3600 (rounded) first requires the S&P 500 to find acceptance below the January low at 4200. The crowd doesn’t expect the low to hold. The market will catch traders off-guard if 4200 holds as the bottom of a new trading range. We will know in the next few sessions – as the market is rapidly approaching the retest level.  Last week, the February monthly candle continued to push down toward 4200 for the retest. The candle remains inside January’s high and closed on its low. A break of the January low is the key to lower prices. Unless Russia triggers a crash, the market is likely to zig zag down. I would expect light hesitation on half roundies, with more resistance at 4100 and 4000. The 21-month and 50-month means, at 4050 and 3335, respectively, can also be supportive. However, monthly charts move slow. Traders are more apt to focus on weekly and lower time frame moving averages.

Weekly Chart

The analysis and targets are the same as the monthly chart in the weekly time frame. The weekly bar also closed near its low and below all key moving averages, adding the 50-week moving average (blue) this past week. The five-week line is resistance (red).

Cyclical bear markets often find support at their 200-week line. That line sits around 3400 and should be carried forward in your narrative.

At this writing and with hostilities breaking out in Ukraine, the holiday global futures market is already close to testing 4200, and the NASDAQ 100 has traded below its analogous low.

Even so, the market may respond to the past six months trading range price action, disappoint the bears, and make the market confusing.

As an example, a short-term move  Tuesday morning to 4000 could quickly reverse and establish the bottom of the new trading range rather than 4200. The conviction of bears will tell the tale.

Daily Chart

The chart above shows the daily chart with overnight data through 7:30 pm on 2/21/2022. On the regular session chart, the current selloff looked like a bear leg in a trading range through Friday’s close. That was before Russia recognized two of the breakaway Ukraine republics as independent countries late Monday (today). The regular session daily chart also appeared to be forming a wedge bottom that is the second leg of a double bottom with the January low.

In normal circumstances, there would be a strong entry buy setup for the wedge swing bottom. The wedge break could lead to a possible breakout of the February high and a measured move back up to test the top of the January – February trading range. Even with the Russia / Ukraine conflict, the odds would be that the market wouldn’t fall far below the January low due to the strong bull trend in higher time frames.

Even at this writing, the S&P 500 is wedging to go higher on a 5-minute chart with the 24-hour data:

Conclusions

Our Navigator swing strategies have been in cash, waiting to deploy on a swing low, preferably the bottom of a new trading range. We are not quite there yet, and global events complicate the decision.

The options market is pricing the weekly expected low and high for S&P 500 Futures at 4229 and 4448, respectively. While that continues the high volatility ranges of the past few weeks, it is interesting that the options market will be defending the lower boundary just above the 4213 January low. It is not as if the options market was ignorant of global events on Friday.

I never forget the axiom “sell the rumor / buy the news.” The market is down at these levels precisely because of known global events and domestic problems. I am wondering why the markets are not worse off in the circumstances. With fear high, tomorrow could be a buying opportunity. We should be bottoming the nominal 20-week and 20-day cycles as well.

The first selloff from a peak is usually brief, 20% or less, and bulls will typically buy the dip to retest the top. The selloff is not likely to last much longer than three bear bars on the monthly chart. We are in our second bear bar at this writing. Just look at the monthly chart and count the last time the market had three consecutive bear bars in a row.

Also, if the market turns here, there will be positive breadth, strength, and momentum divergences on the daily charts.

The cross-currents (inflation equals higher rates – Russia/Ukraine equals kinder Fed policy and lower rates) seemingly facilitate a trading range. Again, context is notably different coming off one of the three sigma tops of the past 100 years. So I will take nothing for granted.

We will see what tomorrow brings and if the low at 4200 can hold overnight.

I will publish Day Trader guidance in the morning.

A.F. Thornton

About all that can be said today is that the market worked its way lower methodically and wedged into the Weekly Expected Move low, where a short-covering rally ensued. Then those who wanted to pair back their long positions for the weekend sold the rally around 4375, and we closed back near the lows of the day.

The positive Gamma associated with rolling puts in the expiration today likely slowed the downside pressure but did not overcome it. The market closed with many puts still outstanding and the put/call ratio still over 1.0. Tuesday will be interesting as participants will come into the market with no relief from the high volatility and negative Gamma exposure.

Today, the market failed to tag any of our downside targets, as the Weekly Expected Move low stopped the decline before reaching them. So those targets remain open.

I wish I had better news for those still in this market. The swing low we seek to deploy cash for our strategies remains elusive. At least day traders picked up a nice short-covering rally.

Have a great holiday weekend.

A.F. Thornton