By: Tom Gentile
on January 17th, 2024
Originally published via our newsletter previously. Subscribe for early access!
Market performance on the year thus far has been relatively lackluster.
The markets haven’t cranked higher, nor have they sold off.
Granted, we are only 7-trading days in to the new year, but the way the markets rallied to end 2023, investors and traders alike are wondering if there is more upside to come or is there a reason to lighten up on their investments and trades resulting in the marketing scaling back.
Economic Reports on the docket this week are…
- CPI – Consumer Price Index
- PPI – Producer Price Index
- Initial Jobless Claims
There is a lot of chatter, and some are expecting the first rate cut in quite some time. Some are saying it could be as soon as March.
The Fed may not say anything right away, but the markets will take these reported numbers, anticipate what the Fed will do and act accordingly – Buy or Sell. It’s at that point we may see a more pronounced move in the market, one direction or the other.
Market in Focus: SPDR S&P 500 ETF Trust (SPY)
Since late October 2023 to mid-December the markets, as represented by the SPY, was on an incredible bullish run.
Since then, it has traded in a sideways range. Call it folks taking the holidays off, a bit of bullish exhaustion or going in to a wait and see mode on what the first readings on inflation are going to be to start 2024.
CPI and PPI, as I stated, come out over the next two trading days.
Even with expectations of the Fed cutting interest rates, maybe as soon as March, their seems to be a bit of a cautious approach lately. Folks seem to be waiting on the numbers being reported this week to see if they will give a ‘tell’ as to if and or when the Fed will actually start cutting rates.
Right now, odds are around 64% they will cut. This according to the CME Group Fed Watch tool.
From the Desk of a CMT – Gold Case Study with Regression Channels
An update to last week’s daily chart for GLD shows price did slip below the middle regression line, but we’re focused on the stronger longer-term trend that remains bullish. Figure 1 includes MACD which was the scan used to identify a bullish set-up, along with the Rate of Change (ROC), a more basic momentum tool.
The regression is drawn for the 10/14/2022 low to 10/6/2023 low and the ROC includes a 7-day simple moving average.
The ROC will be used for this case study which remains as a plan given the current set-up. First, let’s review regression channels.
Regression Line Basics
- Line of best fit – it’s the one that minimizes the total distance from each data point to the line.
- Technical tools typically use closing data and allow a start and end date
- Consider start and end dates that use cycle or trend low points
- Linear regression center line
- Upper & lower lines can be a fixed distance from the center line or can be dictated by price movement for the time period captured by the channel, such as the Raff Regression Channel
Regression Channel Implications
- Regression channel characteristics are similar to other trend lines
- The longer the trend, the stronger the regression channel
- Price is generally expected to move from one channel line to another as the trend proceeds
- The more times a regression line has been successfully tested, the stronger it’s considered
- An area of previous support or resistance is expected to reverse roles and serve as resistance or support in the future.
Linear Regression Channel: Developed by Gilbert Raff, the upper and lower channel lines are drawn parallel to the center line using the time period’s data point that is the furthest from the center line. This means the two lines are different distances from the center line and captures previous extreme movements in the trend.
Raff Regression Channel: Developed by Gilbert Raff, the upper or lower channel line is drawn parallel to the center line using the data point within the time period that is the furthest away from the center line. If the lower line is drawn first, the upper line is then drawn the same distance away from the center line (and vice versa). This construction then captures previous extreme movements in the trend, with some leeway on the line drawn second.
Figure 2 adds the Linear Regression Channel to GLD, which allows the data to dictate channel lines versus some fixed measure.
The change includes a slight change in slope in the middle line and a shift in the upper line.
The last chart drops the Raff Regression and approximates the regression line value on Friday, March 1, 2024.
If the bullish trend continues, we can expect price to move around this upward trending regression line which will be used in this case study as an objective point of reference to build a short-term strategy.
It’s difficult to set the stage for future price action, but that’s the reality you face every day.
I got to a point when showing examples of what happened in the past when everything lined up just didn’t feel informative.
This set-up may or may not play out but the important tools for you to develop are:
- Monitoring conditions and responding to what is for the markets (not what you hope will happen)
- Determining your allocation for the position and
- Managing risk if conditions change or
- Taking profits
Given this simple chart, conditions will be most favorable for a bullish strategy with price above the middle channel line and a cross of the 7-day SMA above the 14-day ROC.
Take a look at what’s happening on the weekly chart and also consider adding a volume indicator to the chart.
Even if you have a set-up with volume also confirming bullish movement, there’s no guarantee GLD will be at or above 193.565 by March 1st, you have to manage risk.
Using Tom’s Options Tools, let’s check GLD implied volatility to see if a call calendar or call debit spread can be queued up.
Relatively low IV currently provides the flexibility to be long premium but remember moves upward can also cause IV to increase.
Review conditions before building your strategy.
The Smart Searcher allows a quick review for specific strategies (Searchers > Multi – Strategies > Smart Search).
Since I somewhat randomly selected March 1st for the regression point, let’s consider an April call debit spread that will be closed thirty days prior to expiration (if conditions allow for the case study before then).
Since conditions have not warranted entry, we need to stay in “what if” mode which prompts questions for you.
If conditions were appropriate for an entry using end of day data on 1/9/2024, assume an allocation maximum of 4% on a $25,000 portfolio, which allows for 4 contracts for the April spread.
The $920 mid quote entry would keep the strategy allocation under the 4% max (3.68%), how would the traditional $500 max risk used in the past fit with risk management?
A single position that represents a 2% portfolio risk is a little high, so for this set-up, let’s ratchet that down to 1.5% or $375. Keep in mind an overnight gap in the underlying could move each option quite a bit, so there’s no guarantee you will be able to exit exactly at that risk level.
However, the spread should help mitigate the negative impact of big moves.
What about profit taking? We don’t expect to travel along the linear regression line drawn in figure 3. Recent price peaks set all times high for the underlying, so setting that price target is challenging.
One consideration is taking partial profits with a bearish cross of the ROC’s SMA back below the ROC line (signals bearish conditions). What other methods can you use if this set-up plays out?
Keep in mind, a timed exit has also been identified for this strategy. Assuming prices will change before any case study can be initiated, follow the logic to put a plan in place if and when bullish conditions return in this channel.
Clare White, CMT
Thank you, Clare!
— Tom Gentile
C1P: Chief 1-Percenter
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