Market Anthropology: Sliding Down Hill

Monday, June 27, 2011

Sliding Down Hill

As the equity markets slide back towards the precipice that comes into view ~ SPX 1257 – it would be wise to keep in mind that assets such as silver and oil have already broken down and started their respective legs lower. Traders should also be aware that it is the end of the month and end of the quarter this week, where, let’s just say – the market has been known to defy the path of least resistance for a moment or three. There is of course the standing concerns in Europe – with a pivotal vote scheduled in Greece on Wednesday and the now vocal admission by various euro members that the real elephant in the room is not in fact Greece – but Spain. All in all your average week…

I find it fascinating that the August 2007 fractal study is correlating on an hourly basis so closely to how the current market is trending. If you remember that time period, it was one of the worst performing months for the large quant firms such as Renaissance Capital. It is not a stretch to believe that the same algorithmic trading systems that make up such a large portion of the daily volume are once again reflexively trading off of each other as the different asset correlations and stat-arb opportunities break down; thus producing the same volatile swings in the market and leaving their artifacts in the charts. The breakdowns in the high yield credit markets, the financials, the currency and commodity markets gives credibility towards that reasoning.

Neo-technically (yes that is my own) speaking, a detail that caught my attention when reviewing the SPX daily chart is the nature of the Stochastic Oscillator. 

The Stochastic Oscillator is momentum metric that follows the velocity of price – not price itself. A main reason I utilize it, is because as a general rule, momentum changes before price. With that said – there are a few patterns and dynamics within the oscillator that can color expectations going forward. One of those is when the oscillator gets embedded along either the top or bottom of the overbought and oversold ranges. Traditionally, they are set at 80 for the top or overbought threshold and 20 as the lower or oversold threshold. 

When an embedded Stochastic develops – it means the prevailing trend is strengthening. It typically occurs most often during strong uptrends. The SPX has exhibited degrees of an embedded Stochastic trend over the majority of sessions since the March 2009 low. For the first time since the bear market bottom – the Stochastic on the daily chart has been embedded around the oversold rail. Granted the range has been expanding towards the mid-point – but as you would notice if you looked at the reverse dynamic from the September low – an expanding range does not necessarily interrupt the strength of the primary trend. Confused?

To make a long story short – the embedded nature of the Oscillator appears to confirm what the fractal study is indicating – a lower low is very likely over the short term. If the Oscillator remains embedded over the next week or so – the bulls hope for a more transitory low will be displaced by an eroding longer-term technical picture. 


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(Position in UUP)

Disclaimer: This is not investment advice. Always do your own due diligence. Erik Swarts is not a registered investment advisor. Under no circumstances should any content from this website be used or interpreted as a recommendation for any investment or trading approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor.