[Click on the picture to watch a detailed analysis of the past 20 years trading in the ASX 200. Over the past 20 years EVERY time we have seen a quarterly sell pivot the market has at the very least sold off from the sell zone of the sell pivot and retested the buy zone or the low of the candle. This time may be different, but if it isn’t what are you going to do to take advantage of it? Watch the video to find out how to put yourself in the box seat for the coming volatility.]
With yet another rally in US markets on Friday we are racing towards crunch time for the markets. Do we have the momentum to bust out above the high from last year? Or are we going to encounter a mountain of selling before long that will knock the stuffing out of the rally and resume the downside momentum that we saw at the end of last year?
In today’s update I focus on the ASX 200 for the analysis and point out why I think the latter is more likely. Even if we are going to take out the high from last year at some point this year it is odds on that we will see some selling pressure come out of the woodwork as the ASX 200 head towards 6000–6250.
Using the last 20 years data in the ASX 200, I explain why the quarterly sell pivot that we saw last quarter increases the odds dramatically that a retest of lower prices should occur before we either turn back up and breakout to the upside or fail completely and revisit 5000.
As the market becomes more bullish and excitement increases about a resolution of the US-China trade biff, the overbought technical situation into the sell zone of a quarterly sell pivot is a very compelling set up that only comes along once every three to five years.
Traders have to respect the fact that the most recent daily, weekly and monthly pivot was a buy pivot, so there is serious upside momentum, but the quarterly chart is the overall fulcrum for the market, so until we see a quarterly buy pivot, we should expect to see longer-term sellers lining up above 6000.
Whether you wait for a daily or weekly sell pivot before acting comes down to the type of trader you are and how conservative you want to be. Waiting for the daily sell pivot means you can have tighter stop-losses and will enter a short trade at much higher levels, but the chance of failure is higher. In other words, it may take a few goes before you get onto a winning trade. If you wait for the weekly sell pivot before acting you have a higher chance of success, but you run the risk of entering the trade at much lower levels if the market sells off a long way before confirming the sell pivot. Also, you have to give the market much more room to move before it will prove you wrong since you are trading off the weekly chart and not the daily.
As I have discussed previously my own approach for gaining exposure in a market like this is to buy puts with plenty of theta (time value) at a strike equivalent to the midpoint of the quarterly sell pivot. There is a good chance that we at least retest that level before deciding whether to rally or sell-off. If prices do revisit that level you can take profit on, say, half of your puts and buy calls with the profits.
From that point on you will have a cheap straddle that can make money whether the market rallies or sells off. Your job is done at that point. You no longer need to watch the market like a hawk and you won’t suffer from heart palpitations every time the market reverses course. You can start to cheer the market on whatever it does. You just need to see volatility.
With the VIX looking like it has entered a new higher volatility phase after years of extremely low volatility, creating trades such as this should end up paying off over time. Even if you have to stick with it while the market treads water and perhaps suffer a few failed trades.
As markets rally and trading ranges contract, implied volatility falls dramatically and purchasing options becomes much cheaper. VIX is now heading under 15 and analysis of past high volatility periods shows that VIX rarely heads below 12, but instead finds a floor around 12 to 16 before spiking again on the next high volatility event. If VIX does plunge below 12, it is probably a sign that the market is adjusting back to a low volatility period due to the reversal of interest rate policy by the US Federal Reserve.
So, we really are heading towards crunch time. The charts are saying that the higher we go in the short-term the higher the chance that we see a sharp correction and traders can use that correction to gain exposure to whatever comes next.
Editor, Alpha Wave Trader