I am out tomorrow, so I will only publish the key levels for day traders in the morning. As most of you know, I don’t typically trade on Friday and I have some family obligations in the morning. I will send any signals if required from my phone.
Today was inflation report (CPI) day. Of course, the number came in hot at 7.5% and likely understated. The market was already expecting a dismal report and rallied on the news. The Fed wasn’t happy with the market’s northern turn, as the 10-year treasury rate popped above 2%. One of the Fed governors (Bullard) was sent out on the talking circuit and rained on the stock market parade with hawkish comments. The algos kicked in, and the market steadily sold off its 80 point rally from the open.
Our cash (non-leveraged) accounts flat stopped this afternoon (meaning we stopped out of the 25% position we had taken in the SPY this morning at our cost with no loss), taking the non-leveraged strategy back to 100% cash. Our leveraged accounts, which had purchased SPY calls when the SPY was at 451.75 this morning, sold the WEM high at 457.50, which had been our target. Subscribers received live alerts.
We trade the leveraged accounts more tightly and actively due to the additional risk and volatility. As of now, the cash accounts are approximately 35% SPY and 35% QQQ, purchased at levels well below the current overnight prices. Leveraged accounts are back to 100% cash as well after three profitable round trips since the January 4th bottom. I will update performance figures over the weekend.
I have mentioned the importance of the 4500 level all week. All round index numbers (‘100 handles affectionately called “roundies”), as well as “half roundies” (the ’50 handles in between), are important. When you pull up some long-term chart data, you will observe that the market dances around the 50 (e.g., 4550) and 100 (e.g., 4500) handles as it progresses up and down. I also mentioned 4520 or so as crucial due to options open interest and the influence of 4500 nearby.
Naturally, we will find many options around these roundie and half-roundie levels, which is part of the dance. There were so many options in the case of 4500 (450 on the SPY), that I suspected the level (give or take 25 points) would continue to act like a magnet (and support) and it did, at least through today’s close.
When the market was some 80 points over the level yesterday and this morning, I was confident that the Weekly Expected Move at about 4570 would cap the gains. But I did not think that traders would draw the market all the way back down to 4500. They did, the catalyst being Fed Governor Bullard’s hawkish statements. Since most of the liquidity sat at the 4500 level, the market gravitated to the liquidity as is typical.
Unfortunately, the futures market is still steadily falling tonight as much as 40 additional points, approaching both the Navigator Algo sell trigger (4445) and the 200-day line (4433).
I will have the updated options gamma/strike price levels in the morning. If the 4500 level is still the dominant open interest gamma, the market may be pulled back up to that level as it was pulled down today. But now that we have breached the level south, it is likely to be significant resistance to higher prices.
The problem tonight is that Europe hasn’t even opened yet – just Asia. European traders could easily pile onto the downswing. The declines today convert both the monthly and weekly candles into red bear bars and put the S&P 500 well below the 21-day and 21-week means.
The lack of buyers/liquidity lately is concerning, to say the least. Also, the uptrend line for the recent rally is arguably broken at these levels – if they are maintained into tomorrow’s regular session.
Of course, what happens overnight does not necessarily carry into tomorrow’s day session, but the picture is not bright at this writing. Also, note that once we reentered the four-day balance range, the market went right to the bottom in the day session per “look above and fail” Balance Rules.
Having dropped below the zero gamma and volatility trigger levels, we can also expect additional index volatility and wider ranges tomorrow – potentially very wide with the negative gamma and a possible gap down. This means that market makers will exacerbate both rallies and declines because they will be selling declines and buying rallies to keep their portfolio deltas neutral. Moves in both directions go further and faster, driving up volatility.
When the market is above the triggers, market makers do the opposite – they buy dips and sell rallies leading to narrower ranges by slowing down and narrowing market moves. The positive gamma environment thereby tamps down the volatility.
If the current decline could be attributed solely to Fed Governor Bullard’s hawkish comments, the market might recover quickly tomorrow morning. Optimistically, a trading range could establish between 4450 and 4580. Only time will tell, but I would be more bullish if fear levels were higher.
We worked off quite a bit of fear in the recent “V” rally, so conditions are not ideal for a low. I am also concerned about low liquidity levels in the markets, and the continued decline in Junk Bonds, often a leading indicator for stocks. The correlation disconnect between the S&P 500 and Bitcoin is also interesting at this writing, as is the upswing in gold.
Even though buying liquidity is low, institutions sold today as reflected in significant volume distribution. And Apple per my morning comments? If it looks too good to be true, it probably is, but the stock is hanging in there tonight at 172.
Be on alert for a sell signal for cash accounts tomorrow. We are in a situation unlike any I have seen in the last 35 years. Inflation is the kryptonite that won’t let the Fed off the hook easy anymore. The inflation numbers have to be addressed and the Fed may induce a recession to put the icing on the cake.
In short, the Fed has stuck its foot into the abyss. The days of inflation being “transitory” that somehow magically fixes itself are over. Deferred pain is still pain, and sometimes it is worse than had we endured it contemporaneously with the Financial Crisis and the Pandemic. The pain promises to be severe now, whether for investors or the country at large.
Before this decline is over, I suspect we will wake up to a limit down morning. That is why we are holding such high cash positions. 100% is best for such a morning – as the opportunities in such circumstances will be terrific. That is if you have the cash available to deploy. Did I mention the Russia and China risks?
There have only been two 50% drawdowns in my 35-year career. If you bought the indexes at the bottom, you could sit on your hands for a long, long time. This market has the potential to deliver such an opportunity. If you are older, you definitely want to miss this downdraft. If you are younger, you want to buy as much as you can at the bottom, as the long-term probabilities are in your favor. Maybe learning Russian or Mandarin is not a bad idea either.
A. F. Thornton