Happy Friday, traders!
Another week in the books, and a wild one it was.
This week we saw something we haven’t seen in weeks — volatility. The daily chart of the Volatility Index (VIX) (below) is an important one to study here. When VIX is quiet, trading in a range near its 21 exponential moving average (EMA) is typically smooth sailing for the markets. However, when volatility suddenly spikes to +2-3 average true range (ATR) on the daily chart, well, you saw the brief impact of that this week. Not always, but more often than not, a move to +2-3 ATR for VIX results in a -2-3 ATR move lower for the indexes, and that’s what we saw unfold.
After an ugly flush under the 21 EMA on Wednesday and Thursday, the SPY (daily chart below) was able to rally its way back above the mean today after an impressive bounce (a good reminder of why we don’t short at -2 ATR. Much of this bounce in the SPY was due to strength in the energy, financial, industrial, and transportation sectors which continue to be the clear leaders in this market (and sectors where we’re looking for upside opportunity).
On the other hand, tech stocks (QQQ) and semiconductor stocks (SMH) continue to be the laggards here, both completely losing bullish structure on the daily charts (below). These are now trading well under their falling 21 EMA points. With this kind of structure, we view stocks in these two sectors as “short the rally” stocks rather than something we’d try to get long in. We like the idea of going short tech stocks like AMZN, but we would need to see a bounce back to the 21 EMA before considering an entry, as we’re too extended to the downside (chart below). Though they could drop lower from here, in terms of probabilities, a short entry at -2 ATR will not likely serve us well over the course of our career.
For new long positions, we want to focus on trading stocks in sectors that have maintained their bullish structure, such as CAT, MMM, and UNP. The new trade we took in CAT this week is a great example of what we are looking for, not only has CAT maintained its bullish structure as the market dipped, the sector it belongs to (XLI, Chart Below) maintained its own structure and continues to show signs of leadership.
For CAT (below), we took yesterday’s bounce off the 21 EMA as an opportunity to open a new position (remember, we caught a nice move for profits on this one last week) with a 6/11 expiration 235/230 put credit spread. Should the structure hold up, we’ll be looking to take profits on a push into $248-$250, which is about +2-3 ATR above the 21 EMA. Should the stock unravel and fall below -1 ATR, we’ll look to cut our losses.
Taking advantage of the flush earlier this week, we sold a call credit spread on TSLA that led to a quick $1,700 profit. This trade was a good example of the kind of structure we look to short, as well as the ideal entry we look to take (near the 21 EMA). On both the weekly and daily time frames, TSLA is showing signs of a breakdown, trading under the 8 and 21 EMA points. TSLA lost it’ positively stacked EMA range, and histograms turned negative.
Once we got the flush to -2 ATR, that was all we were looking for and we took the money and ran. Bearish structure, short entry near the 21 EMA, book profits at -2-3 ATR, rinse and repeat! This is how you trade the ebbs and flows of a chart with a focus on high-probability entries and exits.
Next week, the tone will be set by whether or not the SPY can hold above its daily 21 EMA. If it can hold, stocks in strong sectors such as energy and industrials should continue to move higher. However, if the SPY once again falls under the 21 EMA, this could lead to another leg to the downside for the overall market, which could easily put a damper on the momentum of these leading sectors.
We also suggest keeping a close eye on the VIX. If it stays near its 21 EMA, that fares well for the market moving higher. Should we see another big +2-3 ATR push to the upside for VIX, that will likely send the market right back down.
Just like we do in any environment, we will be focusing on the structure of the overall market (SPY) to dictate whether or not we want to focus on longs or shorts, and will stick to our rules of taking entries at the 21 EMA and taking profits at 2-3 ATR extensions.
Stay tuned for this Sunday’s premium video, where we’ll dive in and cover a few setups we’ll be focusing on in the weeks ahead!
Stay Focused!