Watching for Signs

We use math, quant traders, to try to know what’s coming next. 

It’s not divination but I’m reminded of the bit in the book of Matthew in the bible where Jesus is on the Mount of Olives and the disciples come privately to him saying, “Tell us, when will these things be, and what will be the sign of your coming?” 

I say that humorously (the Amazon Prime show called The Chosen is pretty brilliant and the character of Matthew is hilarious – sort of on the spectrum, a rich tax collector, inherently introverted). 

We want to know the signs of a turn in the market. At Market Structure EDGE, the signs we use are Broad Sentiment and Short Volume (Demand and Supply in the S&P 500).  Context – the cadence and calendar of the market.  Divergence, or Demand and Supply in stocks, sectors, portfolios, the market, moving in opposite directions.   

And we trade VOLATILITY. (For more on that, join the live Discussion Thursday Jul 17.)

The last time volatility was over 1% in the big ETFs tracking the S&P 500 was June 23.  It’s averaging 0.6% since then.  At EDGE, we coined The 1-2-3 Rule. ETF trackers of the S&P 500 tend to move 1% from highest to lowest intraday price.  The underlying stocks move about 2%. Momentum stocks have 3% or more volatility.  One, two, three.

The interplay among those driven by Jane Street and Citadel and Susquehanna (as archetypes for high-speed arbitragers setting most prices, driving half the market’s volume) give us a reliable way to consistently take profits. 

Lack of volatility is the only threat to an arbitrage strategy. Why? Because arbitrage is about buying and selling at different prices (it’s the basis of the Jane Street matter in India – where Jane Street just put up $587 million to satisfy regulators there, so it can return to trading. I wrote about it last week).

If prices all move the same way, you can’t find the arbitrage return.  And then arbitragers quit and the market suddenly shakes. 

The same thing happened in February this year.  After a spate of volatility in December, the arbitrage spreads in the market were consumed by Fast Traders.

Now, just because something occurred in the past doesn’t mean it’ll repeat. But the mechanics of the market have not changed. The participants have not changed. The motivation and principal purpose of the market – the pursuit of arbitrage spreads – has not changed.

By the way, none of this is a reflection of economic, geopolitical or other factors.  It’s about mechanics. Market structure. 

Yesterday (Jul 14), ETF S&P 500 tracker volatility was 0.5%. Half the volatility is 0.25%. If the market is inflecting – hitting a top or bottom – I often will go long or short any total move of intraday volatility. 

Let’s sum up:

Broad Sentiment, the EDGE measure of overall Demand and Supply, is 6.8 and ticking down – falling slow not fast – and Supply is leaking higher.  That’s a product of the absence of volatility.  Slow moves.  And since June 23, S&P 500 stocks have closed above the average intraday price a staggering 75% of the time.  Well, how can buying outstrip selling 3-to-1 sustainably?

Options expire July 16-18.  Earnings are accelerating.  That’s context.  It can alter outcomes.  Stocks TEND to inflect at expirations. 

Finally, there’s Divergence, with eight stocks in the EDGE Momentum Daily Trading Ideas portfolio.  And there are 131 stocks with $100 billion or more of market cap. In January it was 115. The big keep getting bigger. 

Over-reliance on the few is awesome on the way up – it propels everything higher.  And it’s terrible on the way down.  I’m not saying that’s coming.  I’m saying it’s possible. 

PS – Join us Thursday Jul 17 for the live Discussion and we’ll see what’s unfolding.