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Where is the market really headed?
By Chad Butler, RJOFutures
We all know that it is impossible to know for certain; but using solid research and some technical analysis, we can make some solid educated "guesses" from which to formulate a trading strategy.
We are going to key in on the stock index futures this week, but there is information in here for you interest rate and currency traders as well. These markets are all inter-related, and much of what effects one, affects the others.
I begin my week by looking at research from The Hightower Report. Hightower had this to say about the bonds to start the week:
The February 6th Commitment of Traders with Options report showed the U.S. Treasury Bonds Non-commercial position to be net short 83,736 contracts, with the Non-reportable position also net short 63,687 contracts for a combined spec short of 147,000 contracts. With the bond market looking to start the week out nearly point below the level where the COT report was measured, it is clear that the Treasury bond market is once again capable of becoming significantly oversold.
Source - Hightower Financial - Lite, RJOFutures Research
With the bond market oversold, we could see some pressure on rates if bonds retrace. So what does that have to do with stock indices? Well, here are the comments from the same research report:
The stock market has started to adjust its valuation as we predicted at the beginning of last week. However, it is a little surprising that both US Bonds and stocks have seen correlated declines recently and that suggests something is out of sync. With the US numbers recently showing some softening and the trade at the recent high, embracing the idea of "perfect" interest rate conditions, we tag the recent high as a classical overdone condition.
Source - Hightower Financial - Lite, RJOFutures Research
An additional consideration is going to be the price of oil. Oil and the NASDAQ have a strong negative correlation, so it makes sense to watch oil. Hightower had this to say:
March crude oil continued to struggle near the $60 per barrel price level last Friday and prices pulled pack over night on indications OPEC may not cut production at next month's meeting and reports Saudi Arabia is supplying more oil to Asian customers. Despite the appearance of tightening OPEC supplies, geopolitical uncertainty and Nigeria declaring force majeure on some crude cargoes last week there just wasn't enough buying interest to hold March crude oil above the $60 price mark. This lack of conviction has to be disappointing to the bulls and with Saudi Arabia's oil minister seemingly satisfied with current market conditions the bears may regain the upper hand.
Source - Hightower Financial - Lite, RJOFutures Research
So by now, you are probably asking yourself, "So what? What does all this mean, and more importantly, how can I trade off of this information?"
The answer is if you put all of this together, you have a strong case for a market going nowhere. There are some pressures that could drive it higher, but there are equally offsetting pressures to drive it lower. The result is a sideways market. How do the charts stack up against that scenario?
Chart Provided by RJOFutures Research
If you cannot view the NASDAQ 100 Daily, go here.
Here is a daily chart of the March NQ contract. You can see that once we broke the uptrend line in Dec, we have been stuck in this trading range with one failed attempt at a breakout. It is going to be hard to take a long-term directional trade in this market until we break out one way or the other.
Taking a closer look at the daily, we can see that while we were developing this range, the MACD has been weakening. When the market attempted to breakout, the MACD made lower high. So the upward momentum that we had built on through late last year is drying up.
Chart Provided by RJOFutures Research
If you cannot view the NASDAQ 100 Daily, go here.
The S&P and the Dow have not established a trading range yet, although based on the discussion in the beginning of this article, it seems likely that they will follow the NASDAQ into a range. Looking at the charts shows that, although they both continue to trend higher, they are showing the same divergence in the MACD, indicating that momentum is slowing down.
Chart Provided by RJOFutures Research
If you cannot view the S&P 500 Daily, go here .
Chart Provided by RJOFutures Research
It seems likely with the slowdown in momentum, that the Dow and the S&P will follow the Nasdaq and enter into a trading range, consolidating recent gains. That will be a time to watch for clues as to the market's next move - continued upside or retracement.
My overall bias would be for any downside breakout to get follow-through and set up a larger retracement of the current bull move. But I would have to see confirmation from the market before I committed. In the shorter term, this could be a good environment for short option strangle players.
(An option strangle is taking a call position above the market and a put position below the market. A short strangle sells, or writes, both of these options and takes advantage of time decay if the market stays in its range.)
Other short-term players can play the market in this range, long at the bottom of the range, short at the top. If the market does break out to either side, you can get out without risking too much.
For the long-term traders, you could either wait on the sidelines for a breakout. In the futures, this is my usual approach as I tend to enter on breakouts with momentum. Alternatively, counter trend traders could look to use the trading range as an entry, allowing a tighter stop. For example, if your long-term bias is bearish, shorting at the top of the range give you a tighter stop than shorting the breakout at the bottom. If the market breaks out to the upside, you could dump the trade quickly and conserve capital. The reverse is true for those with a bullish bias. Buy the larger pullback, but be prepared to "cut bait" if the market breaks down for a larger retracement.
There is a lot of opportunity in this market for traders of all types. You just have to be able to research the market, and develop a suitable approach for your trading style. The key is quality research. Drawing squiggly lines on charts doesn't help if you don't have some solid fundamentals to back up what they tell you.
In order to provide that helping hand in the research department, RJOFutures is offering a complimentary trial to their quality research. Be sure to ask how you can get a trial to Hightower Research as well.
THE RISK OF LOSS IN TRADING FUTURES AND OPTIONS CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER TRADING FUTURES AND OPTIONS FITS WITH YOUR INVESTMENT OBJECTIVES.
About the Author
Chad Butler is a Senior Market Strategist with RJOFutures, a division of R.J. O'Brien. His 16 years of market experience includes option spread trading, diversified trend following, and development of a number of index arbitrage programs. Chad's published work appears in McGraw-Hill's Complete Guide to Single Stock Futures, Futures Magazine, and other trade publications. He currently writes for various commodities newsletters, including RJOFutures MarketNews and has been a featured seminar speaker teaching his various trading techniques to audiences large and small