Here is a chart of SPY, the second to last candle is last week’s. (Click on the chart to enlarge)

Definition of Doji

So I took weekly data for the SPY, as a proxy for the S&P 500, back to 1993. As a definition for a doji, I took that the closing price – opening price should be less than five percent of the high price – low price for the week. That way the body would be small compared to the entire bar.

Test of the Predictive Power

I tested by comparing the close of the week before the doji candle to the close of the week with the indecisive market; and the week after the doji. If the week before was lower than the week of the doji so that it was an up trend, the next week should be a down week if the candle predicts a change of market direction. Similarly, if the week before the doji was higher, than the close of the doji week, the week after should be higher. It should look like V with the doji at the bottom of the V.

There were 41 dojis since the last week in January 1993, for this weekly version of the test, there is no predictive power.

But that is not how the eye would judge the trend. You wouldn’t look at the nearby week on either side of the doji, you would look at a few weeks on either side of the candle to judge the trend. So I redid the comparison with the close four weeks on either side of the doji.

Of the 40 cases, 26 of them were in the same direction and 14 signaled a change in direction. The reason that there are 40 instead of 41 is that the doji two weeks ago is too recent to count, since I am looking four weeks on either side.

Here’s an updated Market Delta chart for the day’s trade. Note how volume at bid has consistently exceeded volume at the offer for the ES contract (bottom histogram); how we’ve remained below the volume-weighted average price (VWAP) all morning (red line); and how we have accepted value lower by trading increasing volume at lower prices (side histogram). The reason I have my chart set up this way is that it provides me with a quick, visual sense for the structure of the day’s trade.

Where I see traders making mistakes in trading this market is by focusing on what has been happening in the last few ticks of movement, rather than the emerging day structure. That has kept many traders out of the market–or on the wrong side of it–even as we’ve taken out the S3 level. A thorough market perspective also needs to look beyond the day timeframe; that shows how we have moved below last week’s lows and, so far, have accepted value beneath that level. Given that dynamic, bounces that stay below last week’s range become candidates for selling.
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… the subject du jour, the seemingly odd VIX expiration settlement.

The VIX closed Tuesday at 32.69, yet on Wednesday it “settled” at 31.03 with a pretty flat SPX open.

The real oddity though is that June futures closed Tuesday at 31.80, an oddly large discount to the VIX. Now they don’t have to close identically, but 3% off does seem high.

So put in that context, the VIX settlement at 31.03 is not quite as off as met the eye. What was off was the actual VIX close.

Which leads me to think I should practice what I preach. I note often that the VIX is not exact to the point, and never a perfect reflection of volatility in the market. For whatever reason, the calculation on Tuesday night overstated the VIX. The VIX lifted about half a point late in the day. Maybe an SPX put buyer walked in late, maybe the SPX cash closed incorrectly, I really don’t know and it really doesn’t matter. VIX futures and options traders clearly knew the “runup” didn’t mean anything.

Again, the VIX is a stat. There was no arb here, there’s no actual VIX you could have sold at 32.69 then covered on Wednesday’s open. You could have sold VIX June futures at a 90 cent discount and made money however.

So while upon further review the 31.03 settlement does not look quite as absurd, it’s still a bit low, probably a point or so. Which highlights the most important lesson in all this. If you do trade VIX or VIX options, do close anything in or near the money before the cash out, otherwise you’re just playing a lottery on whether you win or lose on the runoff.

The latest Investor’s Intelligence poll was released today, and it showed the highest Bull Ratio since December 2007.  During the prior bear market, such spikes in optimism among the newsletter writers preceded a market deccline every time but once (that exception marked the end of the bear market).

Most interesting is WHY people follow those writers, or anyone else for that matter.  It isn’t because they’re necessarily right more often than not.  In fact, when they engage in group-think, they’re wrong more often than not.

More likely is that they gain a following because they appear confident.  The New Scientist posted an article today which explains that experts who appear confident get taken more seriously than those who might have a more persuasive argument, but who stress the uncertainties in their forecasts.

This is part of the reason why those who are always bullish or always bearish maintain followers.  They can be wrong for extended periods of time, but they’re very confident in their outlook.

And it certainly explains the Cramer Phenomenon.  He’s about as good as flipping a coin, but he sure seems like he knows what he’s talking about (who could ever doubt someone with a sound-effects board?).  Next time your advisor appears cocky, you might want to take a look at some history before just handing him your money.

Source:

Humans Prefer Cockiness To Expertise

The New Scientist, June 10, 2009

Boy, was that a mistake!

GMCR went from 53 at the close yesterday to 73 now (2 PM). So my short straddles are deep underwater.

The writer of the Daily Option Report traded FSLR with an iron butterfly and limited his loss.

Stocks often go nowhere for a while, then change their state and trade at a whole new level.  The reason commodoties seem so much more volatile is because of the leverage.