The Lower-Risk Trade Here

  • July 21, 2004
  • Rob Hanna

Today
was not a good day for the market.  All of the major indices sold off
hard on high volume.  The quick gains that the indices enjoyed yesterday were
all wiped out and more.  Only the Nasdaq held above Monday’s lows (barely). 
Still the Nasdaq dropped the hardest of the major’s (-2.2%) and is very close to
breaking below its May lows.  Of the 25 or so industries I watch on my screen,
everything was red…everything.

 

In Monday’s column I spoke of
the possibility of a sharp selloff ensuing based on the action in both the S&P
and the VXO.  It looks like that sharp selloff has begun.  The “good” news is
that it looks like the VXO has started to spike up.  It may not take a whole lot
more selling to bring enough fear into the market to cause a bounce.  If you
aren’t short already, I’d be careful the next few days.  The lower-risk trade at
this point may be to wait for the next bounce.

 

Since I received several emails
after Monday’s column, I wanted to do a quick follow-up.  (Sorry, I still owe
several of you replies.)  On Monday I noted that when the S&P trends down and
the VXO does not move up, but rather sideways or down, the likelihood seems to
favor a sharp selloff is near. The most common question I received was whether
the opposite of my theory held true.  Opposite meaning if the VXO and S&P are
both rising consistently, does that presage a further rally?  I did some quick
research and found 29 times over the last 10 years in which this occurred.  Of
those 29 times, 16 were followed shortly by a further rally, and 13 times the
market drifted sideways or sold off.  Some of the further rallies were very
significant, though (ie. Jan ’96 and Feb 98).  The edge to the upside is there
but appears to be quite a bit smaller. 

 

In general, I would say it is
noteworthy anytime you see the S&P and the VXO move in the same direction for an
extended period of time.  When this occurs, the odds seem to favor the trend
will continue a bit longer (and many times accelerate for a short period).

 

Best of luck with your trading,

 

Rob


robhanna@comcast.net