Pre-Market Outlook - 5/21/2021 | Archimedes Methodologies

The process of learning to invest and trade can be daunting at first. For many of us, it starts out as a search for the holy grail. Book to book, indicator to indicator, guru to guru – you are always just one step away from trading Nirvana. It is not unlike a search for the pot of gold at the end of the rainbow. And yes, mischievous little Leprechauns are everywhere.

For most of us starting out, the answers had better come quickly because our capital is rapidly disappearing. And if you are anything like me, it is not likely the first round of capital on the journey. There is no experience that compares to being forced into margin liquidation. Tuition – as we affectionately reference it. I have been there more than once on my journey – and we will leave it at that.

One complication of the learning process, however, is that your head can be stuffed full of minutia. The next thing you know, you overlook the obvious – the signal buried in the noise.

In the trading world, everything starts with price action. The rest – no matter what it might be or the claims of promoters – is context. The price is doing x, but momentum is waning. Momentum is context. The price is potentially peaking on the nominal 18-month cycle. The cycle is context. Obviously, context can be ranked in its level of importance but that is a discussion for another day.

Periodically, I will strip everything off my charts and just look at price and price alone. Price is the signal – the rest is noise. First I look at the line chart, then a bar chart, and then a candlestick chart. Sometimes I turn the chart upside down just to trick all my biases. Then I add in some volume. For these purposes, I keep it simple.

Over the past year, with the most aggressive Fed action I have experienced in my career, dips (when they occurred) lasted barely a nanosecond. We have seen a lot of “V” bottoms. V bottoms are the exception. The important pivot lows normally involve a two-step process. The market puts in a low, then retests it about a week later. The safest entry is on the retest.

There is no retest on a “V” bottom. Instead, the price just touches and goes – hence the “V.” You end up waiting for the retest with your hat in hand. Any hesitation and the market has already left you in the dust.

If you ignore all the noise, we just experienced the kind of bottom as they used to be. Likely, this will be more to the norm as we carry on from the giddiness of liquidity, Fed-driven markets. So it would be wise to add this one to your notebook.

So let’s examine this bottom in simple terms:

As you will see from the chart above, we bounced where we should on the trendline. There were other supports there as well, but I don’t want to clutter the graph. That is part of this exercise – keeping it simple.

Note the volume spikes below the first low. Volume typically surges like this when traders are churning indecisively at the low. If you look back to some of the other pivot lows this past year, you will see the same phenomenon.

Then we move on to the Tuesday retest, coming right on cue about a week later. Volume spiked again, but this time it spiked less than at the first low. A spike with slightly less volume tells us that the selling intensity was abating. The fact that sellers could not drive the market into the first low was another tell. The index left a long tail (the close was close to the open) on the day, as traders realized that the bears had lost control. From there, it becomes a matter of follow-through. That is where we find ourselves now.

There was another tell confirming the lows – namely fear. In the circumstances, it is a good time to measure trader anxiety. Fear accompanies reliable market troughs.

The first shorthand for measuring that fear is the CBOE put/call ratio. It tends to spike just like the volume. Too many shorts pile on at the lows, just like too many longs pile on at the highs. But it is at the lows, when the ratio spikes, that we can more accurately predict a bottom. I replaced the put/call ratio for volume in the chart below so that you can visualize the point.

The other fear indicator that is useful at important lows is the VIX (volatility index). Volatility peaks at lows, and diminishes at highs. Like the put/call ratio, the VIX tends to be more accurate at picking troughs than peaks. I replaced the put/call ratio with the VIX index in the chart below so you can visualize the point.

All in all, these simple clues gave us a low-risk entry point for longs. If an uptrend is defined as a series of higher highs and higher lows, and a downtrend a series of lower highs and lower lows, then a reversal is when the process ends, as here. We had a short-term series of lower highs and lower lows until Tuesday, when the progression to lower lows ceased. The process ceased at the trendline, one time frame higher, where the series of higher highs and higher lows has maintained the intermediate uptrend.

In Globex last night, we are breaking the short-term downtrend line (see charts above). We need that confirmed in the regular session today. If we can then clear the high bars from last week to the left on the chart, it should be clear sailing to the old highs. From there? Who knows, but the easy trade is over.

With this market, new highs are possible. It would seem that tech is moving again. Somewhat lost in translation is the fact that tech and growth stocks generally have been correcting for five weeks.

Ultimately, it comes down to math in a capitalization-weighted index. The stocks going up must contribute enough to the index to carry it higher. That is why the stalwart FANGMAN+T stocks are so important (Facebook, Amazon, Apple, Netflix, Google, Microsoft, Nvidia, and Tesla). They may be a handful of stocks out of the 500 member index, but they contribute 25% of the weight.

What I will be watching now is the progression of each daily candle. How far is the price invading the previous day’s candle? That tells you something right there. Is the volume supporting price progression?

And what about the nominal 18-month cycle? It requires an entirely separate discussion. But if we bottomed all of the cycles all the way up to 9-years in March 2020, and this is the first 18-month cycle in that series, it is likely to peak late in the curve. Also, the probability is that the correction will not be a crash – but likely something around 15% to 20% at most. The trough is due the first week of July, give or take a few weeks on either side. That is why we can’t trade it.

The peak is not predictable, as with all cycle peaks. And while the trough is more predictable, there is too much variation. Sure, one could say that we are 75% through the cycle and I will just go to the sidelines until the correction finally presents. While it is not my preference, that is a perfectly legitimate approach. For me, the context of the cycle helps me adjust the risk I am willing to take at this point. But it does not keep me out of the market,

Today's Day Trading Plan

Yesterday, the narrative changed, shifting back into a more bullish tone by breaking downtrends on the NASDAQ 100 and S&P 500 futures. As overnight trade is higher this morning, I will latch on to the more bullish stance.

Options expire at the close, which can hold prices more where they are, especially in the afternoon. That is why I typically don’t day trade on Fridays.

The triple candle peaks out to the left (4179.50) mark the next breakout. The level also marks the 10-day point of control. Conquering that level is the next link in the chain, but it might not be achievable on a Friday with the volume concentration there.

On the downside, and there could be some profit-taking at the open on extended overnight inventory, there should be support at the beginning of the single prints at yesterday’s regular session distribution. They begin at 4142.00. I would also keep them in mind as the area where there is potential for change in tone.

Carry forward that the overnight low came right down to the settlement (4153.50) and not further down in range, closer to those prints.

Always remember the market’s affinity for climbing in 50-point increments. If the index level is on the 50 or 100 point increment, it is likely to stall a bit as it works through or finds support or resistance at that level. If nothing else is relevant on the day, traders like to test the overnight high or low and yesterday’s high or low to find the path of least resistance. So go with the flow, and look for confirmation. Strong internals in either direction often telegraph success or failure at the crucial level.s

If I were trading today, I would give the market 30-minutes and see how it breaks from that candle. In an uptrend, I like to buy dips into the 21-EMA on the 15-minute charts for both the S&P 500 and NASDAQ 100. Let’s see if the NASDAQ 100 can maintain its leadership position from yesterday.

Have a great day and a wonderful weekend.

A.F. Thornton

Pre-Market Outlook – 5/21/2021