VIX Index of Volatility

Larry Pesavento: ‘The VIX index tries to find markets that are overbought and oversold by using the amount of volatility that speculators are willing to assume. When volatility is high there is a great deal of fear in the market. When volatility is low, investors are complacent and not worried about sudden changes in stock movement. This index is probably one of the more difficult trading vehicles as it will sometimes not react to what prices are actually doing. This is not to say it will not work.  What it is saying is that it might not work exactly at the same correlation the trader is looking for in his analysis. The VIX index follows the patterns incredibly well and is tradable, but only for seasoned veterans or those that study the market dynamics for the index itself. As you can see from the enclosed chart it does show very nice symmetrical patterns that can be measured and predicted within limits. At this particular time the VIX index is coming back into the first level of the breakout that occurred in late August and early October. This should find support as it is also an important lightning bolt AB=CD pattern and a 0.786 retracement of the whole move up.

As always it is good to use sound money management and risk assessment when trading anything.  This is especially true with the VIX index because it moves so rapidly that it offers great potential for profits and equally painful losses.’

5-Minute Bar Sets Hourly High or Low

Q:  How do you design an alert when a 5 minute bar is either the high for the last hour or the low for the last hour?

A:  Here is an example where the high and low of the last twelve 5-minute bars is found and then tested to see if the current bar is setting that value.   12 bars were used on the 5-minute chart because that amounts to the last hour.

Head and Shoulders Patterns

Larry Pesavento: ‘Head and Shoulders patterns are one of the most reliable patterns in technical analysis. The key to making a perfect head and shoulders pattern lies in the time between the head and the left and right shoulders. In other words, the ideal situation for the technician is when the time between the left shoulder to the head and the head to the right shoulder are equal which makes a perfectly symmetrical head and shoulders pattern. The calculation is simple because all you have to do is to count the number of bars from the left shoulder to the high and from the high to the right shoulder. Also look for a Fibonacci relationship between the head and the shoulders. The expansion of the left shoulder to the high will usually be 1.27 or 1.618. The contraction from the high to the right shoulder will usually be 0.618 or 0.786.  When these ratios come together exactly at the time when the symmetry is showing, the pattern is one of the best trades a technician can get, i.e. low risk with high profit potential.’

Silver Natural Trend Line

Larry Pesavento: ‘Notice the recent lows in the silver market for the past few weeks. Each low has been a 61.8% retracment of the previous swing low.  This phenomenon sets up a natural trend line of higher lows that held until the last 61.8% retracemnet failed at the $33/oz level.  What is also important to the technician is the fact that the rally following the break of the 61.8% level stopped once again at the exact high of that rally which was near the $33/oz level.  The next piece of the puzzle will be in play if silver can retreat to the major 61.8% level of the last major low @ $29.83/oz.’

2012 Trade of the Year in TBT

Larry Pesavento:  ‘For the past several decades I’ve issued a trade of the year based on butterfly patterns. Though these traits have been correct 90% of the time there have been a few small losses.   Here are a few of my past trade of the year recommendations:

  • 1999 – Buy crude oil at $11 a barrel.
  • 2003 – Buy gold.  Also sold the Euro at 164 and bought it back at 85.
  • 2009 – Short treasury bonds and that led to a very large win.
  • 2010 – Short the Dow Jones industrial average which worked well for three months and then the market had a spike which took out the trade at breakeven.

This year’s trade of the year is going to be short treasury bonds by using the ETF TBT.  Buying  TBT at $17.17 cents per share with a $3 stop gives a very adequate risk reward ratio in my opinion.

The long-term thirty-year chart’s trend for interest rates has been down since 1981.  For the past 30 years our government and citizens have been using paper money via bonds, mortgages, and credit cards to live a lavish lifestyle many far beyond their means. Now is the time that this is going to change if my analysis is correct as we see a final (at least I think it’s final) leg up in treasury bonds bringing the yield on the 30 year treasury bond to near 2.5%. I asked myself this question, is there anyone that you would lend money to for 30 years at under 3% given the history of what’s happened to inflation during that time? The answer is a resounding no. This would be the fundamental factor that I would think would make this trade work. But it is only a trade and carries with it some risk.’

Bank of America

Larry Pesavento:  “The next Lehman Brothers???

Bank of America has fallen in value by 90% since the 2007! It is the largest bank in the United States and is dangerously close to going below five dollars a share. Historically stocks a drop below five dollars a share usually go into bankruptcy better than 85% of the time. Bank of America would certainly be a bank that would be in the category of “too big to fail” by most people’s assessment. However, the protest groups on outcry Wall Street will make it difficult at least temporarily for legislatures to take over Bank of America. Citicorp the third-largest bank in the United States looks even worse as it has had a 10 to 1 reverse split and has dropped more than 95% of it’s value since 2007. Fortunately all the executives are still making their multimillion dollar salaries and all looks well in Camelot. Whether Bank of America will be the next Lehman Brothers remains to be seen. But if you’re Chartist, as I am, I would be very skeptical of owning either of these stocks.”

Forex Trading – A Technician’s Dream!

Larry Pesavento:  “The US Dollar Index is a good example of using technical analysis to determine trends for entries and exits in foreign currency trading in 2011. The strong trending years of 2007 through 2009 have gone by the wayside.  Lets narrow down technical analysis to three areas:

  1. Pattern Recognition – The chart for 2011 has several AB=CD lightning bolt patterns. In addition, there are several Gartley patterns during the year. HM Gartley describe this pattern in his classic book ‘Profits in the Stock Markets’, published in 1937.
  2. Fibonacci Ratios – Only the four major ratios of the Fibonacci sequence 0.618, 0.786, 1.27, and 1.618 are needed to describe price movement within the pattern recognition signals. These ratios we are the most common and the most reliable. The goal is to keep it simple rather than reinvent the wheel.
  3. Cycle Analysis – Using standard cycle analysis from Edward Dewey and James Hearst we come up with a nominal cycle of 62 days.  This cycle is repeated four times during the year.

Armed with just a few of these technical analysis tools the market mystery behind the US Dollar Index is not really a mystery at all.  Trading comes down to risk control and money management.”

Live Cattle Daily AB=CD Pattern

Larry Pesavento:  “This week’s focus will be on Live Cattle.  The live cattle market is forming another AB=CD pattern following the same pattern for the past few months. The last AB=CD pattern into new high ground is very important as it means a breakout has occurred or a bear trap has been set.  Notice the shaded pink areas on the chart as the cattle began their “bull” run. Harmonic moves like these are on all charts and I highly recommend technicians look at them as they are telling a story of cycles in price!

COW, the ETF for cattle, has lagged badly recently which may be another clue as to a potential top in cattle. It is my opinion that this emphasizes why some ETFs are not a good proxy for the actual futures account, but can still be used for exposure in retirement accounts that allow that type of investment.”

IBM 3 Drives to Top

Larry Pesavento:  “IBM is completing 3 major patterns – the Butterfly pattern, a 3 drive to top pattern, and an AB=CD pattern.   This strongly suggests a major top.  In order to control risk the best strategy is to buy the Jan 180 put for $5.00 or less.   IBM is expected to announce earnings this week!”

T-Bonds Weekly Thunderbolt

Larry Pesavento:  “Thirty years ago in the spring of 1981 the yield on the 30-year treasury bond issued by the US government was above 16%. The bond carried an 8% coupon, but the price of the bond had dropped below 46. This meant that you could buy one hundred thousand dollars of treasury bonds for $46,000, and cash them in at maturity for $100,000. In 1981 inflation was rampant above 15%, gold had retreated from its high of 865 and ounce, and the country was in turmoil to say the least. Since that time, interest rates have dropped every year over the past 30 years making this one of the longest bull markets in bonds in history. The chart we are showing today is a long-term weekly chart of the thirty-year T-bond.

Several patterns are apparent to the trained eye. Of particular interest is the pattern that is completing at the present time known as the thunderbolt, or AB=CD pattern. This pattern measures equal and parallel moves and is present in just about everything that trades with a liquidity on the worldwide basis.  In addition a double top can be seen. This has the potential of being the trade of the decade, i.e. interest rates are going higher. No one in their right mind thinks this could happen but just looking at the charts it appears that this could be the case. The downgrading of U.S. Treasury bonds and notes by Standard & Poor’s did little to slow down the upward move of these instruments and make rates go even lower. What we’re waiting for now is a sign that the top is finally in. This sign will come after we have a correction and then one more retest hopefully at the 61% retracement were we can enter with a stop above the reason highs of 144. Bonds have not stopped going up as yet and they could still reach 151 making new highs from 2008.

Ask yourself this question, is there anyone that I would lend money to for 10 years at a rate of 1.9% per year? I think we all know the answer to that question.  However, the prevailing financial minds believe that rates are going to go even lower. Herein could be the big surprise for the rest of this decade.”