All posts by AF Thornton

Founder's Trading Journal

Morning Outlook – Stop Triggered

AF Thornton 0 Comment

We are trading below our stop this morning, which was around 3915 on the S&P futures contract last night. Sellers were conspicuously absent yesterday, so if you did not trigger an overnight stop, yesterday’s low at 3696.50 is the most important key level for today’s trade and the level I will monitor to exit the market intraday, as opposed to waiting for the close. A breach of 3696.50 puts the balance area low at 3828.75 into play while remaining above 3696.50 tells us the market is remaining in balance and still looking for more information.

So stay tuned for alerts today, as a breach 3696.50 is a potential gateway to further weakness towards the balance area low at 3828.75. If we stay above that level, prices should be seen as balancing to higher. Responsive trading (moving through our usual conditions testing overnight highs and lows and yesterday’s highs and lows) may well the be best course of action today as there seem to be competing biases right now. Remember, if we go down and come back up through the open, screens go green.

A.F. Thornton

Founder's Trading Journal

Buy Signal

AF Thornton 0 Comment

I just issued a Navigator continuation buy signal to the Founders Group on the S&P 500 Index Futures at 3915.25. The risk here is significant. I will be using the 5-day EMA on the daily chart as the stop. I am looking for a close below it to stop out. You can use the same strategy on SPY calls – using the 5-EMA on the SPY as your reference.

The market held 3900 this morning, so it is not quite ready to break yet. The buy signal actually came right around the 3900 level, but I waited for more confirmation. I will be 90% invested, retaining 10% for the XLF and XLE if the opportunity presents itself. There is a healthy representation in the S&P 500 already for both energy and financials.

Going into this market is one of the most difficult decisions I have had to make in some time. Realize the considerable risk at this moment. At the same time, if the decision was easy it would not be a good decision.

A.F. Thornton

Founder's Trading Journal

Living with the Risk

AF Thornton 0 Comment

Navigator Algorithms – 100% Cash

S&P 500 Index Futures – Trend Reversal Imminent

10-year treasury rates rocketed yesterday. Perhaps we finally found the Achilles heel of this market. Another way to look at this is that the powers that be are selling bonds aggressively pushing yields higher, which pushes the dollar higher and gold lower. Now I have my gold answer too. I was trying to reconcile what appears to be a 7-year gold cycle peaking.

If rates move too far (say the 10-year tops 1.5% from its 1.3% current level), or they move too fast (say by Friday), it may be curtains for the stock market. Wasn’t it just a few weeks ago we were told that the Fed had rates “under control?” Recall what I said a few weeks ago – add $279,000 billion per year to the deficit for each percentage point rise. What will the Fed do now? 

I owe you a discussion on MMT or Modern Monetary Theory – the left’s new “this time its different” argument. Deficits don’t matter. We shall see.

Meanwhile, I avoided the XLF and XLE yesterday – not because I want to – but because the market may grab onto our coattails and drag us into the water. I am not giving up – just evaluating whether I can live with that risk.

Last night’s Globex trading was flat until just a few minutes ago when retail sales beat estimates by a lot, as did industrial production. This has caused a small true gap lower, putting gap rules into play. Good news can be bad news for interest rates.

Yesterday’s RTH session came down into the prior large balance area but really only inside Friday’s spike high. There was no real acceptance back into that larger value area. Overnight prices have explored that a bit further but are currently trading back outside. 

Today’s session will be all about whether or not the market moves back into balance or not. If so, then there is potential to move back to the opposing end of balance at 3878.50, which is the February 10th regular session low. So today is all about testing the overnight low at 3910 – hence in practical terms – a test of whether the 3900 roundie is solid or not.

Interest rates are now the glue holding this house of cards together. As Goldilocks would say, we want our interest rates served not too hot and not too cold.

A.F. Thornton

Founder's Trading Journal

Morning Coffee

AF Thornton 0 Comment

Navigator Algorithms – 100% Cash

195-minute (half-day candles) Chart of S&P 500 Futures Index

Despite our holiday yesterday with our stock market closed, Globex futures still traded for the non-US markets. Indications are that we will open with a gap higher in the cash markets this morning. Interestingly, we have a discernable 5-wave advance from the February 1st low, indicating that this latest rally phase could peak today.

Hopefully, you had a chance to read Jeremy Grantham’s piece highlighted in last night’s post regarding the likely formation of debt and equity bubbles. From here, we have to trade what is in front of us, fully cognizant of the risks. The XLF and XLE still pique my interest if they can break out to new highs this week. The two sectors now sit at their most recent swing highs, leading to a double-top if the market fades.

Interest rates remain on a tear this morning – with the 10-year US Treasury Yield hitting new highs at 1.267%. Rates could be the catalyst for the next corrective phase in equities, so I am keeping a close eye on them.

The market has blown through most of my target, upper channel reference lines. The Weekly Expected Move range is roughly 114 points – with the upper reference at 3987 and the lower reference at 3883 (also near last week’s low). Perhaps the market will try to conquer the 4000 psychological level – or fall just short of it.

The opening gap would represent a breakout from the recent five-day balance where value (the area representing 70% of volume) was unchanged. Today’s trade will need to hold above the high of Friday (3935) to keep the balance breakout intact.

Because of the large and emotional single print late-day advance on Friday, spike rules also play. This morning’s open is the most bullish outcome if it can hold above the spike as per those rules. Acceptance back down within the spike will also confirm the higher prices.

As with all shortened weeks, we ignore the tiny distribution range from Globex yesterday and overnight. Key levels reference Friday’s trading.

Finally, gap rules are in play, and we have a solid (true) gap higher this morning. Overnight inventory is 100% net long, and if you put Sunday and Monday night’s distributions together, we are trading close to the midpoint of them. Early trade will be all about the gap fill or lack thereof.

As per the usual plan – let’s see how the market reacts to our four key reference points; the overnight high and low and Friday’s high and low. We will follow the market where it finds acceptance. Coming too far into Friday’s range could indicate that the move outside of the balance range has failed and would blunt the latest rally attempt, taking us back to retest 3900 or so.

Founder's Trading Journal

Waiting for the Last Dance

AF Thornton 0 Comment

The chart above is a good visual reference of our current market state. The top half shows the S&P 500 index’s current distance from the 200-day Simple Moving Average. The bottom chart shows the CBOE Put/Call ratio and its distance from where the market typically ends an intermediate correction. The two graphs move in opposition to each other.

Since my strategy and algorithms are based on mean regression, consider the 200-day line to be the “intermediate” mean. We are a dangerous distance from that line. At a 26% distance, this is more than we have experienced in a long, long time. Mean regression is like a rubber band. Stretched too far, price snaps back with a sting. The sting is proportional to the leverage involved. Suffice it to say, the leverage right now is unprecedented, and the rubber band is due to snap back soon.

Confirming that possibility, the bottom half of the chart is the CBOE Put/Call ratio. The indicator measures the sentiment of retail traders – the crowd that tends to arrive near market peaks. The lower the ratio, the higher the complacency. The ratio has reached the lowest level in my 34-year career. In short, the indicator shows too much bullishness – close to a long-term record.

In other words, excessive optimism is pervasive among retail (not to mention institutional) investors. We only see this near market tops. There is little to no fear in the market, and yet it keeps falling to record lows. As Ben Franklin once said, you want to buy on the canons and sell on the trumpets. The trumpets are blaring – but the question is for how much longer? That is not an easy question to answer.

There are titans in this business. One of those titans, Jeremy Grantham, is In the same league as Warren Buffet or Sir John Templeton. Mr. Grantham is an understated but legendary investor. Born in 1938, he will turn 83 this year. I will be lucky to live that long, much less have his perspective. 

Mr. Grantham is a British investor. He is co-founder and chief investment strategist of Grantham, Mayo, & Van Otterloo (GMO), a Boston-based asset management firm. GMO had more than US $64 billion in assets under management as of October 2020. Mr. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets and is particularly noted for predicting various bubbles. He has been a vocal critic of different governmental responses to the Global Financial Crisis from 2007 to 2010. Mr. Grantham started one of the world’s first index funds in the early 1970s. In 2011 he was included in the 50 Most Influential ranking of Bloomberg Markets magazine.

Every once in a while, I will read something that crystallizes my thinking. There is no point in rewriting or paraphrasing. I could not improve it. Tonight, I would like to share just such an article. “Waiting for the Last Dance,” written by Jeremy Grantham at the end of January. The report is a simple yet powerful presentation of the dilemma before us. Enjoy the read. It is not long.

I will put out the outlook in the morning, as I don’t want to dilute Mr. Grantham’s impact.

A.F. Thornton

Founder's Trading Journal

Diamonds are Forever

AF Thornton 0 Comment

As proof positive that I am here in my office playing computer games and enjoying my coloring books, my latest rendering above is a diamond formation using half-day candles (195-minute) on the S&P 500 index. As the wife says, “if the shoe fits.”

But honestly, there is such a formation in the markets, and it typically occurs at a top. The “diamond formation” words above are linked to the Investopedia technical definition for those interested in the details. For now, realize that the breakdown of the formation leads to a measured move down from the corner of the formation equal to the distance from the top to the bottom of the middle of the diamond. We would look for evidence to reenter around that measured distance.

In our current case, the distance is 50 points. Since we are cornered around 3900, we would look for bottoming action around 3850. The market still must confirm it is grounding there for us to reenter, because the 50 point move is the minimum to be expected.

So why do these patterns develop, giving us such predictable consequences? I am not sure we will ever know the precise answer to that question. I suspect it is because we are all playing the same computer game. Perhaps it then becomes a self-fulfilling prophecy.

Given the pattern and its connotation that the market is balanced between bull and bear forces until the design breaks, I view the key references today as go/no-go triggers. Use the 3928.50 all-time high as the upper reference point to negate the pattern entirely. 

Use the 3909 settlement (close) as neutral. Incidentally, the S&P 500 futures have settled at that same 3909 close for four sessions in a row. I have never seen that before. The “settlement” at the futures pit in Chicago is considered the final “closing price.” The price can vary slightly from the print close you see on your quote service.

A violation of the balance area low at 3878.50 would indicate that the pattern is on its way to completing the top formation. That would leave the projected mark low at 3850 as a target. 

The volume point of control sits just above that at 3855.25. I will be using the 5-minute chart at those levels to look for bottoming evidence. Exploration below 3850 connotes more ominous behavior – so be careful. The cyclical pull here is not strong – so we should pass through this mid-month low without a bloodbath. That is my best guess.

If the diamond discussion is all for not because the music is still blasting at this party, the curfew sits around the upper channel line and Weekly Expected Move high at 3950. Given all of that, the trade I am looking for is likely to develop later rather than earlier in today’s session.

The intermediate, swing-trading Navigator model is 100% in cash. It may throw some buy signals at the 3850 targets. We shall see but stay alert.

A.F. Thornton

Founder's Trading Journal

Stalling the Plane

AF Thornton 0 Comment

As a young child, my father bought several airplanes to lease out to the flight school at the old Freeway Airport in Tucson, Arizona. When you are a kid, flying in your own small plane can be quite a thrill – except when a commercial jet is landing behind you.

Freeway Airport Circa 1966, Tucson, Arizona

Of all his planes, my favorite was a “V” tailed Beechcraft Bonanza. Again, when you are only 8-years-old, the “V” tail is cool – and different from the other planes. Always the curious cat, I wanted to know how this worked and why it was different. In fact, I wanted to know everything about the plane, flying, etc., and my father often gave me the steering wheel to fly. It was not as easy as it looked, and I had to learn to give it a light touch. Just like the markets, it is easy to oversteer.

Beechcraft Bonanza “V” Tail

I enjoyed flying but never pursued it as an adult. Let’s say I know myself too well. I am an absent-minded professor.  I spend too much time in my head. Indeed, I would be the one you read about in the papers who forgot to put the gear down before landing the plane.

Instrument Panel

I often say that flying an airplane on instruments is one of the best analogies I know to the skills necessary to successfully navigate the markets. You learn to trust your instruments. When flying In bad weather, you cannot always see the ground. Many a plane has been plowed into the side of a hill when a pilot trusted her “gut” instead of her instruments. We did not have GPS in those days.

When my father used to let me fly the plane, he often told me not to pull back too hard on the wheel. He would explain that if the plane went up too fast at too steep an angle, it would stall. After a stall. and absent the skills of an experienced pilot, the plane could end up spiraling straight down. 

I have applied this aerodynamics lesson many times to the markets – as the principle is much the same. As an example, take a look at the chart of the NASDAQ 100 below from the start of this bull market in 2009:

NASDAQ 100 Index – 2009 to Date

If that were the flight path of an airplane on a radar screen, guess what happens next? There are no guarantees in navigating the markets, but I consider myself a skilled pilot. And even if I landed the plane we find ourselves in now with the gear up, it would still be a lot better than trying to pull the plane out of a spiral after the stall.

So if I seem a bit cautious of late, hopefully, you can see that there is a method to my madness. There is nothing normal about the current situation – and we are living on borrowed time. At some point, we will have to pay the piper. Incidentally, the Piper Comanche was my second favorite plane. I wonder if the social justice warriors will require a name change?

Today's Plan

The liquidation break I had been expecting the last few days finally came and went yesterday. It was a 40-point air pocket in the S&P 500 futures – not a pleasant ride unless you are short. Interestingly, the market tested above Tuesday’s high and then below last Thursday and Friday’s lows – but landed smack dab in the middle by the close.

Chart Below is a Carve Out from First Chart Above (The dark blue candle is yesterday and the light blue candle that follows is the overnight action so far today):

As I have often communicated, liquidation breaks strengthen the market, as the poorly positioned longs and weak hands are eradicated, at least in the short-term. But the exploration above and below recent highs and lows typically gives us scant clues about what the market wants to do next.  This morning’s level is not a great position to establish longs either, unless you are willing to be super attentive.

Moreover, this particular leg of the rally rose on diminishing volume, except for yesterday.

Chart Below is a Carve out from First Chart Above (Note the diminishing volume on each daily candle until yesterday, when volume spiked):

So, as Joe Biden’s new press secretary often drones, “circling back” to my airplane analogy, the volume spike on the outside day yesterday is another sign of “stalling.” We often see this kind of candle behavior and volume spike near short-term peaks and troughs.

Having said that, the red line on the charts is the 5-day Exponential Moving Average, and it is providing support for now. That will be a key line in the sand if you are still in the markets. As has been the case recently, we handed the ball to the bears yesterday and overnight, but they keep fumbling. The bulls have the ball for now.

We grabbed some timely profits yesterday on half of our XLF and XLE positions. So we still have a small exposure to the markets (a leveraged 3% in calls).

The trigger for consternation yesterday may have been the inflation numbers. Both the consumer and wholesale inflation numbers were tame and less than consensus estimates. We will be tracking these numbers closely for the foreseeable future as the deflation/inflation debate is a key theme for our near-term sector allocations.

Consumer Price Index

The US’s annual inflation rate was steady at 1.4% in January, the same as in December, and slightly below market forecasts of 1.5%. From an annual perspective, central upward pressure came from food prices (3.8%), used cars and trucks (10%), utility gas service (4.3%), medical care services (2.9%), shelter (1.6%), electricity (1.5%) and new vehicles (1.4%). Meanwhile, apparel prices fell 2.5%, and energy costs went down 3.6%, mainly due to gasoline (-8.6%). 

On a monthly basis, consumer prices went up 0.3%, in line with forecasts and following a downwardly revised 0.2% rise in December driven by a 7.4% rise in gasoline cost. The indexes for electricity and natural gas declined, but the energy index rose 3.5%. Food prices rose slightly by 0.1% as an advance in the index for food away from home more than offset a decline in the index for food at home.

With deflation still a considerable risk in a potential collapse of the gargantuan debt bubble at hand, markets would like to see inflation pick up. Given the rise in oil and commodity prices of late, I don’t think the financial markets will be disappointed with the February numbers published in March.

As price value and the settlement on the S&P 500 futures contract have been virtually unchanged for the last three sessions, there is little impetus to react strongly one way or the other at the open. I will trade from the basic framework that while the market is still overbought in the short term, there has been some corrective activity (a liquidation break) that might strengthen it as it goes. I am cautiously bullish unless price finds acceptance in the lower single prints, paying close attention to where value develops.

My approach always is to follow the market as it tests the overnight highs and lows and yesterday’s highs and lows to see where it grips. References above are yesterday’s high (also the all-time high) of 3928.50, settlement over the last three sessions at 3908.75, the top of the single prints at 3889.75, and yesterday’s low (also the bottom of the single prints) at 3878.50. The references to untouched POC’s and the top of Gap in the previous two morning outlooks should also be carried forward.

The bulls still have the ball, and my best guess is that they have one more small push to the top channel line visible in the first chart above before the mid-month cycle low draws us down.

A.F. Thornton

Founder's Trading Journal

Cutting XLF and XLE Positions in Half

AF Thornton 0 Comment

The liquidation break I had been expecting has arrived, and while the XLF and XLE are bucking the trend, I want to take profits on half of each position as we approach the old swing highs here.

When approaching an old swing high, there is no guarantee we will punch through it. If we do, then we still have half the position. Always remember that calls involve considerable leverage, and the short-term enthusiasm in the market generally is overdone. The market can drag the XLF and XLE down with it in a correction, no matter how much we like the sectors.

A.F. Thornton

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