One of the little factoids I've often shared is that in a primary bear market, we typically have just about as many up days as down days, volatility. We have even more volatility at each of the transitions from one stage to another whether that cycle and its 4 stages be over a period of a month, a day, or a primary trend of 5 or 6 years.
The 4 stages we almost always see in a market cycle in any of these timeframes above are the base /accumulation which is stage 1, the breakout and move higher which is stage 2 called "Mark-up" or "Participation". Then stage 3 follows, which is generally speaking distribution/top (although distribution often starts late in stage 2 mark-up and finally stage 4 decline which follows the top.
I have mentioned volatility individually with each stage and I've covered it as a whole. We almost always have increased volatility at transition points between stages, that volatility may take on different forms, it may be an increase in the daily ATR (Average True Range) as is common early in stage 2, it may be in the form of strong head fake moves late in stage 1 on a head fake/stop run before the move to stage 2 mark-up. One of the more common changes in volatility we have seen often is at the end of stage 2 mark-up in which price's Rate of Change (ROC) increases in what I often have referred to as a "seemingly" bullish manner. This is generally seen when stage 2 follows a moving average and late stage 2 it suddenly peels away from that moving average to the upside, often causing Channel Busters and other events that lead to stage 3, that's why I say, "seemingly bullish" because most of the time if you were to buy the increased upside move, you'd be underwater not long after or in a dead, lateral choppy market often seen at stage 3 .
Then there's an increase in volatility at stage 3 as it ends with a head fake or a common Igloo with a Chimney head fake. This is often where volatility increases, but choppiness gets more intense until late stage 4 when volatility increases again with a more straight line drop towards the end and the highly volatile, capitulation event, again, all of these are at transition points between stages.
This is where you have to know what kind of trading you are engaging in for the environment and partly is the reasoning for holding UVXY, I would have to make a decision whether I was going to be short term trading and moving in and out in an increasingly volatile market which is fantastic for this type of trading, or whether I was looking at a more trend oriented position, in which case things like moving averages are helpful to smooth out the noise , but not understanding what type of trade you are pursuing and not understanding the nature of volatility and where it occurs causes mismatches between your anticipated trade plan and your reaction to volatility. As I think you've heard me say and I'm sure you've experienced in your own life, "Use the right tool for the job". I've talked about that a lot in the use of options from my perspective, I love them for tight places where I need more leverage and want to get in and out, but they are far from my first choice for a trend trade as everything about them is constructed to work against you with longer time periods.
I grabbed a couple of charts to illustrate what I mean. Somehow it's one thing to look back at a chart and everything looks reasonable and understandable and it's quite another when you're on the right edge of the chart, but this is why I'm so big on understanding the stages of a cycle, know where you are and you have a good idea of where you're going.
This is a macro example of the stages in a primary trend...
Note how stage 2 MARK-UP remains in a steady trend marked by a red trendline for 2+ years and recall that "Increased upside ROC in price" at the end of stage 2 that is "seemingly" bullish? At the yellow arrow and my note you can see price peel away from the former trendline, increased volatility which runs right into the 2007 stage 3 TOP.
It seems to me a lot of people expect declines to be straight line drops. If you look at the downtrend and start of stage 4, there's a large increase in volatility, but it's within a choppier zone than what people commonly expect, however if you follow my small orange hash marks on the chart, each one is a lower high and lower low, the very definition of a downtrend and in a primary trend sense, a bear market or stage 4 DECLINE.
At the end of stage 4, again volatility picks up just like at the end of a stage 2 rally and that's where there's a near straight line drop, but this too is often a warning signal that the trend is about to change. This scenario of increased volatility at the end of stage 4 decline most often ends with a very volatile event that is called "Capitulation", which is like one big , massive selling event typically recognized by a large gap down on huge volume.
As a side note, this rarely is the actual bottom or the start of the cycle all over at a stage 1 base, typically price drifts lower after capitulation and drifts right in to a new stage 1 BASE as it did in the first quarter of 2009.
Almost all of the concepts above, we see on a daily, weekly or monthly basis, that's why I call concepts like this "fractal" and I didn't go looking for or cherry pick a chart, I just grabbed the last complete cycle, but for an even wilder ride, look at the start of the 1929 top and stage 4 decline. After the initial drop which was huge, there was a 5 month rally of +50% which is rarely noticed by people looking at the time period as it is dwarfed by the rest of the trend, but at the time it was huge for the Dow. I'd encourage you to go back to the 1929 top and slowly move your chart forward through time and see how you would have reacted emotionally yo each of the events because too many people look at the trend and think it's a no brainer short, but a 50% move against the initial drop shortly after it started after a decade of immense gains, you'd be awfully confused and I doubt many people would have had the wherewithal to sit tight.
I? think studying historical charts in this manner, putting yourself in the emotional moment (if possible) is one of the best ways to learn about mass psychology and market behavior because of it.
You may recall, at the time (both at the anticipated decline from the head fake move at the September highs which was stage 3 of the August cycle, I felt very strongly , despite my market outlook, that this wa not the top and when sentiment indicators hit record bearish levels at the October lows, again, I did not think this was the top and in fact had gone the other way and expected a "Face ripping " rally, even before we had the objective evidence of accumulation, there were simply too many people calling a top at the time, too many people on the same side of the boat.
Ironically we are at the exact opposite now with even CNBC posing the question, "Is it different this time?" just this week. I saw the word count of "Different" used in one night on CNBC within that context and it was over 40 times, that's the kind of sentiment tops occur in, just like the vivid memory of CNBC pumping the author of the book, "Dow 20,000" at the 2007 top that has stuck with me.
This stage 4 decline was very strong and more importantly very effective as mass psychology goes as it produced record high levels in several sentiment readings by 3rd part sources. From the head fake area (Igloo w/ Chimney) looks like a pretty clean downtrend, the kind of straight line move many expect, but take a closer look...
Again, just like the increased ROC at the end of stage 2 Mark-Up, the increased ROC at the end of stage 4 is a warning sign that things are about to change and we had started calling for a bottom several days in advance while everyone was convinced this was the one that wasn't coming back.
I put the moving average there, just because I didn't have my pad out to draw the obvious roll over in the rounding top area. This is a transitional area and volatility is likely to pick up, whether that's increased ATR of the daily candles (the daily range) or whether it manifests in a more volatile move to the downside, history and mass psychology tell us it's more likely that we see an increase in volatility in a choppy downtrend until we reach that point of the straight line drop, but the straight line drop here is far from the norm.
This is exactly why I have had to make decisions about whether to leave UVXY in place for a trend move or whether to take a nearly 8% gain in less than 2 days, I think I posted my reasoning and in that, I understand the trade I'm looking for, thus the tool (type of trade) has to match the job.
Again, here are the charts for VXX/UVXY updated this morning and why I again decided not to take an even bigger gain today, VIX in the mix.
Remember the intraday charts mostly 1-3 minutes which are full of noise as intraday volatility has clearly picked up...
Thus, while I have no argument with anyone wanting to trade shorter term among the increasing volatility and maybe taking gains like yesterday's 3 hour market exposure in UVXY of +6% or today's day and a half and nearly 8%...I've decided that I want to use this tool in a trend fashion, that means even though we can see it coming on short term intraday charts just like yesterday and today...
This is the trend I'm looking for...
VXX and UVXY charts from 5 mins through 60 min all leading positive in a huge way at a "W" type bottom area.Much in the same way, while we identified the 1/29 -2/2 base and I could have easily closed shorts and went with longs for the move, I'm looking for a bigger trend and I expected to see underlying trade behave in a certain way on an advance...
I'm not saying anything even remotely close to "Don't piggy back trade" or swing trade here, there's opportunity that was identified in advance, I just choose to take the larger perspective.
Remember working on AAPL for months and being practically laughed off StockTwits as I had said AAPL is seeing distribution and is going to move significantly lower in 2012 when AAPL was hitting new highs everyday and AAPL could do no wrong. AAPL longs were WORSE than the goldbugs of 2010-2011.
The point is as you may recall (I definitely recall as it was a hard lesson), I had a short position in place only a few percent off the top and decided when I saw a small positive divergence that I would close the short and wait for the little bounce the positive divergence was suggesting and then re-enter AAPL short at a slightly better entry with slightly less risk, then the Dan Loeb news hit and AAPL never turned back, never gave me that counter trend move to get in. A trade I had nailed and been in place for worth 45% (or more if it had been pyramided up as you can do with equity shorts- non ETF) all because I treated my trend position like a swing trade and lost out.
I suppose Jesse Livermore stated it more succinctly in saying,
“It was never my thinking that made the big money for me, it always was sitting.”
“Money is made by sitting, not trading.”
“Men who can both be right and sit tight are uncommon.”
While I disagree and many of you have proven that the above quotes are not the final word on trading, in the AAPL situation, the above applied and I took a tool meant for one thing and used it for another, the failure to align my trade plan with the trade management cost me a fantastic gain. In other words, I had AAPL right, but didn't sit tight or you might say planned my trade , but didn't trade my plan.
I hope this of some help as we are obviously entering volatility.
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