NEWS / Foreign Exchange

Where Did All That Volatility Go?

by Gabe Velazquez

It seems like just a short time ago the markets were going through plenty of wide intra-day gyrations that provided us E-mini traders with extensive opportunities to profit most every day. For the time being this is no longer the case. What happened?

In the last two weeks we have been witness to some excruciatingly narrow days. The volatility index (VIX) has dropped from the low twenties about a month ago to where it sits today, roughly around thirteen. We can attribute this in part to some holiday light-volume trading sessions, but also to the lack of conviction on the part of most market participants. The Market seems to be on hold here in anticipation of the upcoming earnings season, due to kick-off this week.

In the past I've written about making adjustments when market conditions change, just as a poker player must play the cards he or she is dealt. For the trend trader like myself, this type of market requires more than the usual patience. The issues we face are two-fold. First; when all we have are five to seven points intra-day, a reasonable risk reward ratio becomes very difficult to manage. Secondly; there are few, if any, sustainable trends to trade.

In my opinion the discussion of risk reward ratio is vital for traders to fully embrace. Think of it in terms of simple mathematics. World class traders aim to have a win-loss ratio of about 60%. To put it another way, for every 10 trades they put on, they will lose money on 4 of those trades. In order to overcome these odds, it makes sense that they have to make (at minimum) twice as much as they lose in order to maintain a consistent level of profitability. Theoretically, if you profited one dollar for every dollar you lost, and your win ratio was 60%, you would have a gain, right? Now, let's subtract slippage, commissions, taxes and other expenses (you see where I'm going with this). This is the reasoning behind the maxim "cut your losses short and let your profits run" and by the same token the saying "you'll never go broke taking a profit" is a falsehood. I've known many Ex-Traders who took lots of small profits and one huge loss. I think it would be more accurate if the maxim were worded "you are less likely to go broke, if you take large profits and minuscule losses."

The ER2 held the critical 800 level, which I wrote about in my last piece. This also happens to coincide with a 38.20% retrace from the prior attempt at filling the gap (chart below).

It seems that the February 27 gap which I've alluded to in previous newsletters is proving to be staging the battleground between the Diehard Bears and the emboldened Bulls. Since Gap theory tells us that most Gaps are eventually filled; the question becomes, which Gap will fill first?

In observing the hourly chart below we indentify an opening gap higher on April 3. Also, by drawing a trend line from the recent lows to today's (April 9) close, we can surmise that the intermediate -term trend is up.

To summarize: earnings season is upon us. The markets will be looking to the results, and more importantly, the forward guidance of most bellwether stocks as a compass for future movement. Most expectations have been ratcheted down, so the room for upside surprises is wide open. Geopolitical tensions seem to have simmered off for the time being, and assuming the Subprime monster doesn't rear its ugly head again, I will have to give the Bulls the benefit of the doubt for now. Based on this premise, my focus this week will be to identify low risk-high reward entry points on the long side.

So until next time, I hope every one has a profitable week.