Tom’s Weekly Newsletter May 31, 2023

Originally published via our newsletter previously. Subscribe for early access!

Technical Analysis can Provide an Advantage when Trading

The Market Focus page of this week’s newsletter will highlight what a failed breakout of a security looks like in the charts.

4-trading days ago it looked the SPY was going to break out and run higher.

It did break out but did NOT run higher.

Much of what seems to have been the driving force behind the breakout and subsequent break down is the unresolved matter of what Congress will do regarding the debt ceiling.

Right now, when we get an announcement that things are getting closer to resolving and congress will either extend the deadline of when their payments are due to corporations, or they will raise the level of debt higher so as not to default the markets leans higher.

When we get an announcement like we did this morning, where things are in a stall and democrats and republicans are still far apart in coming to an agreement to resolve things the market sells off.

The markets do NOT like uncertainty and that is playing out / proving to be the case and it can be seen in the charts.

Market in Focus – SPY

5-trading days ago SPY broke out. What that means when a security breaks out is it closes above a resistance line in a price formation.

416-417 was a resistance as it formed a double top over the date range in the chart shown.

An aggressive approach one can take is trading the day after the breakout.

A more conservative approach is waiting at least 3 trading days for the price of the security to stay closed above that resistance.

SPY almost did that but traded lower, closing below that resistance meaning the breakout has now failed.  A move down to prior support at 405 is possible unless Congress resolves that debt ceiling concern. 

From the Desk of a CMT – DE Case Study Probability Cone

The DE case study included a probability cone review, which is a great visual that’s part of the probability calculator.

When you get familiar with the tool assumptions and how changes impact the probability conesand curves, this calculator is a good reality check for the strategy you’ve selected.

A review of component stock charts for XLI resulted in further analysis for DE and UPS since both were approaching overhead resistance when using the Fibonacci chart setting. 

It was noted that DE earnings were estimated in 17 days and:

• Nearby resistance was at 385.84 with support at 367.38
• Short-term and intermediate terms trends were bearish (SMAs)
• RSI was in bearish territory

UPS earnings recently passed and:

• Nearby resistance was at 183.32 with support at 159.14
• Short-term and intermediate terms trends were bearish (SMAs)
• RSI was in bearish territory

ATM-IV conditions for both stocks are shown in Figure 1.

Two case studies were selected using the Smart Search tool and the following long put strategies saved:

1. DE May 26 380 put @ $10.90.
2. UPS May 26 175 put @ 3.10

I didn’t post a UPS case study but encouraged following the method we’ve been using to find a strategy that suits your style for UPS or other industrials in XLI.

Figure 2 provides the strategy set-up on 5/2/2023, including the Statistics & Probability table found below the risk charts. Note support at 367.38 was below the downside breakeven and was added as a price target in the calculator settings (displayed later).

Before moving to the probability chart link, Figure 3 displays the back test results for the strategy since 5/2/2023.

With two days before earnings, the price broke down below the support level. 

DE opened at $365 the next morning, providing an opportunity to exit before the IV crush when earnings were released.

A quick view of the probability cone with default settings shows DE moved consistently down, following the -1 standard deviation curve pretty consistently.

Not what you expect every time but within DE’s historical price action.

Next (figure 5), we adjusted the input to reflect:

• An exit by the earnings date,  
• Updated the IV value to 40 to reflect other pre-earnings volatility spikes, and 
• Price targets reflecting the breakeven and Fibonacci support

Although I’m repeating a good amount of information from the last article, I believe you can gain a better understanding of these tools when you take some time to look back at them and see how the inputs played out. 

Interestingly enough, IV did spike to 40 on 5/17/2023, two days before earnings.

A key reason for using the probability analysis was to determine the likelihood of the strategy making money if DE did move down to the next area of Fibonacci support and IV spiked higher.

We also had to model these assumptions in a compressed timeframe. 

It certainly worked well to have price move down along the -1SD curve and you shouldn’t expect that regularly going forward, but the probability price would touch our second target served as a good reality check for the strategy.

Regards,
Clare White, CMT

Thank you, Clare!