Here Comes the Hard Part + Open Interest for SPY, IWM & QQQ

Here we are again sitting at all time highs, overbought, with a very low put to call ratio and the sense of complacency upon us. Does it sound familiar? Well, if it doesn’t, then this must be your first year in the markets. So why is this the hard part if we have been here many times before? We are overbought with signs of waning momentum so longs set-ups are more scarce, riskier, and subject to failing right from the start. However, we also just made another new high and  the market is trending up so taking shorts is like trying to play pin the tail on the donkey (i.e. picking a top).

As I stated last week, the biotechs were beginning “to exhibit signs of exhaustion and we may start to see some rotation out of  biotech and into other sectors.” Financials were one benefactor of the move away from biotech. That is notable because when financials lead it is suggestive of a bullish market. Furthermore, the financial bid is being confirmed by high yield spreads dropping (also bullish for stocks).

When we have reached a similar juncture in the recent past, the tendency has been to remain rangebound and choppy obeying different support and resistance areas. In this type of a market environment, less is more and patience is a virtue (see the bottom to read more about how I trade during these periods).

Waning momentum exhibited by 20-day highs in SPX not being confirmed with 20-day highs in stocks. 

Overbought based on stocks above their 20-day moving average (red) and beginning to roll over, often leading to chop. 

Open Interest: (For open interest on momentum stocks see here)

SPY: Typically seeing this type of open interest at this stage (just making new highs and not yet churning up top) is more bullish than bearish. All the open puts should help act as support starting with 187. Keeping that in mind, if we get a pullback to 187, it might provide a good buy opportunity for a short term trade. However, as I’ve mentioned before, if 187 is taken out, because of all those puts underneath it, we could see an ugly sell-off due to delta hedging (typically it would happen closer to the end of the week). 

IWM: Not as helpful because the high strikes don’t have as much meaning with the small caps, but still better to see this for the bulls at these prices than the reverse. 

QQQ: Again, better to see, but of less importance. 

Regarding how I trade during this time: My tendency is to trade less and allow my swing trades (trades lasting a couple weeks to a couple months) to do the work. For the current swing trades I have open, I will tighten their stops so as not to lose the profits already there. Any new trades I initiate will be ones I deem to still have very good risk/reward attributes within a more shaky market environment. Those set-ups are based on on a lot of research I do, both fundamental and technical. I also go into this type of week with a few potential short ideas that I could put on if I decide they provide a good opportunity. For those of you interested, starting April I will be providing a subscription service where you can get my personal watch list beginning each week as well as real time trades and other good information (open interest etc). For more information, please email me at rsassy.spy@gmail.com.