Can't Beat the Races

"You can beat a horse race, but you can't beat the races." - How to Trade in Stocks, Jesse Livermore

I've tried to beat the races, and it is very hard to do.  Maybe only a few non HFT firms are capable of doing it, such as a Renaissance Technology.  It is hubris to think that you can predict short term moves accurately enough to make money everyday, against some of the smartest people on the planet.  Its possible if you are willing to play in less liquid niches where hedge funds and HFTs can't play in.  But if you are in big, liquid markets, you are playing a game that's tilted against you: having to pay the bid ask spread with adverse selection against players with better information.  

While its almost impossible to beat the races, it is possible to beat certain individual races if you are selective and know what to look for.  I have given up trying to make money every day.  I am not a salaryman.  I don't want to act like one.  The biggest mistakes are made when you try to catch every little move up and down, lose the forest for the trees, and miss the big move.  Or worse, go on tilt while losing and turn a small loser into a big loser.  That's another advantage of trading less.  You give yourself fewer chances to have a mental breakdown.  

The money is made in catching a couple of big moves a year, not in catching a lot of small moves.  The last trade I made, shorting SPX, was an example of a short term trade gone awry, holding too long, turning a smaller short term loser into a larger longer term loser.  Only those with great discipline, who are quick to cut losses should play in the short term trading game.  And even then, the odds are against you. 

Last Monday, I mentioned 2 scenarios where the SPX could go which would affect my view on the next 2-3 weeks.  They were the following:

SPX 5550 was the pivot.  

The first path:  If the SPX stays below 5550 for most of the next 3 weeks.  If the SPX trades mostly below 5550 and stays choppy in a 5350 to 5550 range, then another leg down is likely.  Under that scenario, the SPX retests the 5200 level, and possibly undercuts the lows of August 5.  

The second path:  If the SPX stays above 5550 for most of the next 3 weeks. If intraday volatility dies down with no moves below 5450 for the next 3 weeks, then you are looking at a grind higher into the FOMC meeting and the first rate cut of this cycle, possibly making new all time highs, with a pullback post September opex and in October to be mild, with the SPX bottoming above 5350.  

A week has passed, and the SPX traded above 5550 for all of last week.  In fact, we finished at a closing high for the week on Friday after the widely anticipated Jackson Hole speech.  So far, it looks likely the SPX will be following the second path, and grind higher into early September.  The SPX has shown immense strength since the August 5 bottom.  Its been a V bottom, and that usually happens in a bull market.  In most of these V bottoms, the market goes up for a minimum of 4 weeks from when the bottom is made, which points to a grind higher till at least September 3.  

I had a bearish bias going into the start of last week, but the market proved me wrong.  The big drop in early August clouded my analysis and I stayed short perhaps a couple of days too long.  It cost me about 50 SPX points overstaying the short position, but that kind of rocket higher off a V bottom was so unexpected given how saturated long the market was just a month earlier in mid July.  It shows you how markets have changed in an era where systematic trading and hedge funds all rush in and out in unison, leading to moves happening more quickly, both up and down, with fewer pullbacks than in the past.  No one wants to be caught short, or even underinvested during these V bottoms.  They can kill relative performance for fund managers who are all benchmarked to the S&P 500.  That's why they chase, because they can't fall behind.  Its goes down on oversaturation in long positions, and systematic fund selling and stop losses.  It goes back up on the chase to re-initiate longs to keep up with the indexes.

The latest COT data shows what was expected given the price action, which was asset managers getting more net long.  We also got very aggressive short selling from leveraged funds.  Leveraged funds are not as obvious of a positioning indicator as the asset managers, but you generally do not get big sustained down moves with leveraged funds heavily net short.  You can get sharp, quick drops like you saw in late July and early August, but you usually don't get the 2022 style bear market with leveraged funds heavily short.  And currently they are heavily net short.  

SPX COT data as of 08/20/2024

 

We did see a big increase in call options volume and a big drop in put/call ratios last week, so the options speculators are back to betting on markets going higher.  Not a sell signal, because this has only been going on for a few days, but if the call speculation continues for a couple more weeks, then I would be looking for a possible top in the SPX.  

 

Last week, Jackson Hole was viewed as a market positive with Powell more dovish than expected.  I prefer to fade these post Fed moves, but will wait since its Monday, and options speculators love to buy calls on Monday and Tuesday.  Even more so this week with so many looking to speculate on further upside going into NVDA earnings.

Of course, the big event this week is the NVDA earnings after the close on Wed. Aug. 28.  I am already seeing a lot of calls being bought in the August 30 expiry weekly options.  Almost all the analyst reports are bullish heading into the earnings report.  NVDA has beaten earnings and rocketed higher so many times lately after earnings reports, that the speculators are betting it happens again.  The options speculators have loaded up on calls, most of which will be closed out win or lose after the NVDA earnings comes out.  That's a huge potential amount of call selling that's waiting on the other side of the event.  With speculators selling NVDA calls, dealers will have to close out their short call hedges by selling NVDA stock.  Positioning wise, its setting up for a sell the news event with optimism very higher going into earnings.  I am considering an NVDA short early this week to take advantage of options speculators leaning way to heavily into calls.  

With regards to the SPX, I see very little upside from here, maybe 50-70 points or so, and that's not good enough considering we could easily pullback to last week's lows, which are about 60 points lower.  The odds of a further 50 points higher is probably similar to the odds of a 50 point move lower.  I see little edge there.  However, if we do get a 50 point rally from here, it would be an interesting spot to short the all time highs in SPX going into a seasonally weaker September.  I would rather wait for September to short, but if we get a 50 point rise from here going into NVDA earnings, I may make a small short play for a post NVDA earnings selloff on Thursday and Friday. 

Cannonball

The bulls have jumped back in the pool.  And it wasn't a smooth rip entry.  It was a cannonball dive, meant to create as much pain for those underwater as possible.  The shorts last week were swimming in the waters that the bulls cannonballed into, and got crushed.  After the bonanza for short sellers from mid July to August 5, there was going to be some payback.  Shorts didn't expect this much payback this quickly, but a combination of options expiration fuel burning puts and gaining momentum from calls above 5500 gave us that screaming move higher last week. 

Its still a bull market.  An aging bull market that's in the late stages, but still a bull.  Traders got a reminder of that this week, as you got a V bottom off the August 5 low, with VIX being crushed down to under 15.  The vol sellers won again, as the market just wasn't weak enough to keep VIX even in the high teens.  It was another triumph for the dip buyers, although they had to take more heat than last time, and I'm sure quite a few got hurt badly.  

The COT data for SPX futures showed asset managers reloading their longs back to near the highs for the year as of Tuesday, Aug 13.  This doesn't include the explosive move higher last Thursday, so this coming Friday will likely show even more asset manager net longs.  They are almost back to where they were before the pullback.   

 ISEE index also shows a strong rebound of call buying, as options speculators have regained their confidence that the market will go higher.  

Equity investors have mostly shrugged off the weakness from a few weeks ago and are back to their bullish bets.  Given the euphoria and high bullishness in the first half of July, I would be surprised to see the SPX go right back up to those levels.  The bulls have already used up a lot of their vol selling fuel, with VIX going below 15.  They also have been steadily buying calls last week so many options speculators have already reloaded.  Also you didn't see the ETF outflows for a true capitulation in early August, so conversely, I don't expect them to suddenly chase this market higher with big inflows in the coming 2 months ahead of the election.  

From browsing Twitter, most have gotten bullish again, with many more believing that this market will continue higher than those that think we’ll get another big selloff.  The bulls are quite sticky, and firm in their beliefs.  Its almost as if we’re back in the early July mentality again.  

I imagine it will be difficult to sustain this level of bullishness with the market coming up on the seasonally weakest time of the year over the next several weeks. The monthly opex last Friday had a big influence on pulling the market higher as all that gamma from out of the money calls got into the money, as well as the vanna effects from the IV plunging last week killing put deltas.  It was a lethal combo.  Some of that opex fuel should be given back early this week.  

Now we are in a fork in the road, with SPX 5550 as the pivot.  There are two paths.  The first path:  If the SPX stays below 5550 for most of the next 3 weeks.  If the SPX trades mostly below 5550 and stays choppy in a 5350 to 5550 range, then another leg down is likely.  Under that scenario, the SPX retests the 5200 level, and possibly undercuts the lows of August 5.   

The second path:  If the SPX stays above 5550 for most of the next 3 weeks. If intraday volatility dies down with no moves below 5450 for the next 3 weeks, then you are looking at a grind higher into the FOMC meeting and the first rate cut of this cycle, possibly making new all time highs, with a pullback post September opex and in October to be mild, with the SPX bottoming above 5350.  

Don't have a strong lean towards either the first or second scenario.  I don't think market will suddenly plunge, or rocket higher from here, so traders have time to wait to see how it unfolds.   I would lean towards putting on shorts in early September, perhaps after the nonfarm payrolls is behind us, and before the September FOMC meeting on September 18. 

Under the 1st scenario, I would short aggressively in early September, and go max short.  Under the 2nd scenario where the SPX lingers above 5550, I would play it safer and scale in more slowly into shorts and not put on a full sized position. 

I haven't talked about bonds much but its getting interesting again.  I think the trend lower for bond yields made a capitulation low on August 5, after the nonfarm payrolls report on August 2 and the panic calls for an intermeeting Fed cut from those with their hair on fire on August 5.  I expect higher lows and higher highs in bond yields from now till the end of the year.  Its not because of the economic data or Powell eager to get rate cuts started to get that soft landing.  Its because of politics.  The election is in November, and bond investors had a couple of traumatic post election experiences in 2016 and 2020.  Considering how likely it is that both Trump and Harris will pursue inflationary fiscal policies, bond investors will not be looking forward to the election results.

I see too many investors that are leaning towards the economic weakness view, looking at the rear view mirror, while the latest data has shown that the weakness is likely overstated.  Jobless claims, retail sales, and ISM services reports were stronger than expected.   The economy is definitely slowing, but not enough to meaningfully affect corporate earnings and credit spreads, which is what really matters for the market.  A reversal of some of that economic bearishness will lead to bond yields going higher.  It was interesting to see last week that the CPI came in weaker than expected and bonds weren't able to rally on that number.  It feels like the long side is saturated in the bond market. 

Got in way too early on the SPX shorts last week.  Deep underwater, but I see plenty of opportunities to make it back for the remaining 4 months of the year.  Will look to exit this week looking for a post opex pullback, but don't want to stay short beyond Tuesday.  Not willing to make a bad short term trade into a bad long term trade.  Probably should have just been hands off after closing shorts 2 weeks ago, but was trying to play for the little wiggles, and got burned. Another lesson that I should avoid short term trading and only look for intermediate term setups where I have more conviction and am willing to hold for a few weeks.  That is why I avoid daytrading as much as possible. 

Diamond Hands

They are impervious to weakness.  They believe.  In SPX We Trust.  Like those Reddit meme investors.  They have diamond hands.  They don’t get shaken out easily, and are willing to ride it out, come hell or high water.  

Last week, we hit the short term pain threshold for some index put options sellers and VIX call sellers, as well as some asset managers.  But overall, you didn't get a true purge that you need for a V bottom.  Which makes it likely that we'll repeat what happened in February to April of 2018 where you bottomed off the initial volatility spike higher and rallied hard, but then sold off a few weeks later to retest the lows.  You probably don't get as much of a rally this time, as Feb. 2018 had a bigger selloff and was during a more seasonally favorable period of the calendar.

Compared to 2018, the price action is much more subdued this time, and you had less capitulation.  You didn't even get a retest of the panic like Feb. 2018 after a few days because the dip buyers and vol sellers were so active.  Which is unusual because the economic conditions are worse now than in early 2018.  In early 2018, the economy was actually strengthening globally, with commodities prices rising along with bond yields.  Now, global growth is clearly slowing as shown by the weakness in commodities and the recent strength in bonds.  

The VIX closed at 23.39 on Friday, Aug. 2, and the SPX closed at 5346.  After last week's panic, VIX closed at 20.37 on Friday, Aug. 2, while the SPX closed 5344.  So you had the SPX lower on the week, with volatile intraday moves, yet the VIX sold off 3 points.  That is the power of active vol sellers in this market.  They suppress the IV of options, reducing the delta hedging and gamma forces in the market,  supporting the indices.  As of Tuesday August 6, leveraged funds (in blue) added to their VIX short positions, basically doubling down on their bets shorting volatility.  Dealers (in red) remain very long volatility, as they take the other side of the leveraged funds positioning. 

 On the other hand, you finally got capitulation in the yen carry trade.  The huge net short position held in JPY by trend followers and carry traders has been purged over the past couple weeks.  You are unlikely to see much yen strength from here in the short term, which is a positive for risk assets.  

For the SPX, you saw asset managers significantly reduce their net long positions from July 30 to August 6, as they usually do during big selloffs.  But asset managers are not completely dumb.  They have a tendency to reduce their net positioning from max long as the SPX enters the final stage of a bull market.  Examples include early 2015, early 2018, mid 2021, and now mid 2024. 

SPX COT Asset Manager Net Positions

Asset manager net positioning is a reflection of Wall Street sentiment.  Bullish sentiment on the market usually tops out before the SPX does.  So the best time to make bets for a big sustained down move is after the bullish sentiment has been decreasing for a few months while the SPX grinds higher.  For example, the bullish sentiment peaked in January 2018, but the SPX made a higher high in October 2018, right before a big sustained drop lower. Same thing happened in November 2014, where bullish sentiment peaked in late November, but the SPX made a higher high in the spring/summer of 2015 before a waterfall decline in August 2015.  It also happened in 2021, where bullish sentiment peaked in the summer, and the SPX grinded higher all year before the bear market started in January 2022. 

It appears now that we've reached peak euphoria for this bull market in July, with the mix of the AI bubble, Trump election hopes, sudden embrace of small caps as the Russell 2000 squeezed higher, and with bonds rallying on Fed rate cut hopes.  I don't think we'll be able to top that level of bullishness for this cycle.  I expect bullish sentiment to slowly drop over the next few months, while at the same time, complacency remain as the SPX stays in an uptrend.  Then like a lion escaping its cage, you can expect a sudden start to a raging bear market.  Best guess is that bear market starts in the first quarter of 2025.  

The ETF flows over the past month are more evidence that investors got really excited about the stock market.  Comparing 1M to 1Y flows, you see how much has suddenly flooded into equity ETFs.  You also had big inflows into short VIX ETFs.  Net inflows for SVIX for the year have all happened in the past week.  You don't see that when investors are scared.  And there was very little selling by equity index ETF investors during this selloff.  This is a short term bullish sign, as it shows that US stock investors are acting like meme stock investors, having diamond hands.  But its a long term bearish sign as investors remain heavily long equities and stay complacent despite the volatility.

OCC opening put/call transactions showed some more put buying than the previous week, but still below the levels that you saw in mid April.  You only got a partial capitulation, and many are still hanging on to their positions, or even adding to them, which means you still have plenty of underwater longs in this  market.  It makes the next few weeks harder to trade as you didn’t get a full capitulation which can be the springboard for a strong rally.  Now its more likely to be a choppy bounce that will lack the buying power that you saw after past bottoms.  But you have gone down quite a bit over the past 3 weeks, so its not a great spot to put on shorts either.

After last week's bottom, we're in a short term bullish relief phase in the market.  You will likely see the more "conservative" bottom pickers come in this week to buy stocks as the charts look better and it looks less scary.  In fact, during this phase, which can last up to 3-4 weeks after a bottom, its better to look for spots to get long than to get short.  

I would be careful trying to short a rally too early before its matured because the SPX can grind higher from here for several days.  At the same time, you can have sudden sharp 1-2 day selloffs that shake out the late coming, weaker hands.  Timing a good short will be harder than timing a good long during this relief rally phase.  Its a different strategy now than the one used from mid July to August 5.  For the next couple weeks, you have to be quicker to exit shorts in profit and be more willing to buy dips.  

Bottom line, its a mixed picture.  You had capitulation in the yen among CTAs and carry traders, and among some asset managers, but not in equity ETF buyers or vol traders.  For the rest of August, it should grind higher, with brief, but sharp dips that will likely be bought up quickly.  Beyond that, looking out into September and October, expect another wave lower back towards SPX 5200, or a slight undercut of last week's lows, in the seasonally weakest time of year, ahead of the election in November. 

Emotional Roller Coaster

They don't make it easy on the short side.  It has been a roller coaster ride since the island top made on July 16.  For shorts, in order to catch most of the down move from mid July to early August, you had to withstand an 80 point drawdown on day 4-5 of the selloff, and a 160 point drawdown on day 11-12 of the selloff.  That face ripper on July 31 on FOMC day truly tested the mettle of the bears.  It looked similar to a lot of the past V bottoms you've had over the past 15 years.  On that Wednesday, you had a lot of BTFD conditioned bulls shouting bottom on that day, and it shook the conviction of a lot of bears.  

I must admit, I was getting a bit nervous there, as the overshoot towards SPX 5560 made it look like a V bottom.  It was definitely not according to plan.  You can thank short term FOMO buyers and short term options flows for causing such a huge squeeze in the middle of the biggest down move this year.  Thankfully, that face ripper reversed quickly, because there were some doubts that were creeping in from past scars of being short after a V bottom. 

After a face ripper like that, it is natural to want to cover your short quickly afterwards on a selloff, to avoid that pain again.  Or if you were long, to just hang on during the ensuing selloff so that you can catch another whoosh higher.  

With all the spastic short term options trading these days, you get these ridiculous overshoots that can really test your nerves.  There are positives to the options flow.  If you are selective with entries, you can get great prices to enter either shorts or longs into the overshoot.  You saw that on Monday as the longs puked out their positions, which was reinforced by gamma and vanna forces in options as vols blew out.  Of course, you have to be ready to catch those overshoots by having pre-determined levels where you want to buy or sell. 

After the violent moves of the past several weeks, it shows how important psychology is in this game.  You had the relentless up move off the April bottom into the euphoric July top, where bulls were celebrating and shouting while the bears were getting crushed and despondent.  Then the sharp reversal which destroyed a lot of late to the party bulls and rewarded the timely bears who stuck with the fundamentals and data. 

The analysis is the easy part, going through the ups and downs when you have your own money on the line is the hard part.  The markets are much more a psychological test than an analytical one.  A slightly above average market forecaster who has a good psychological game will be a better trader and investor than an excellent market forecaster who is undisciplined, and falls for the temptations of locking in wins quickly and hanging on to the losers hoping they come back.  

In order to survive in this game, you have to be more like a gambler than a salaryman.   Gamblers enjoy the stress and tension of making a bet and riding the ups and downs.  Salarymen want regular wins, at regular intervals, and get stressed out experiencing the ups and downs of holding on to volatile positions.  The world of trading is not designed for the salaryman mentality.  No trader wants to be considered a gambler, but the financial markets are a glorified casino.  It fits those that are comfortable with volatility and risk.  Of course, too much risk is just asking to get blown up.  One has to ride that fine line between taking enough risk to get meaningful returns, while not taking too much risk which leads to blow ups.

There are many failed traders who go on to selling subscriptions to have a steady income and avoid getting a real job.  Psychologically, its much easier to sell subscriptions and have that be your main source of cash flow than it is to rely on speculation as your sole source of income.   Trading on the side as a part time pursuit with a full time job or with subscription revenue is not the same as having all your income based on trading.  That's why you see so many traders come and go on Twitter, but the sub sellers are always there.  Selling something. Trading as a profession has to be one of the lowest success rate endeavors out there.  They say 8 out of 10 businesses fail.  I would guess that more than 9 out of 10 traders fail. 

Speculating is stressful, and it lures traders to try to maximize emotional comfort.  This leads to overtrading and wanting to reduce risk quickly when winning.  Its human nature to want to hang on to losing trades, hoping they come back.  And its human nature to want to get out of winning trades, fearing that the gains will be given back, and to book a win.  Its not natural to hang on to winning trades, hoping for bigger gains.  That’s why I like to put on price targets for trades, in order to have a goal for the trade.  Its a psychological tool for staying in winning trades, to ride them out as planned.

When you are holding a big position, there is stress and tension that only gets relieved once that position is completely closed out.  The psychological temptation is always there to close out that winning position, to relieve the tension and reduce the stress, to give yourself the win.  That temptation is much weaker when holding a losing position.  While closing a loser relieves tension and reduces stress, you are also locking in a loss, admitting to losing, which most people naturally hate to do. 

Back to the market.  Monday was capitulation.  It came a couple of days faster than expected, but its hard to get both price and time correct.  At least the price targets were hit, and it went beyond expectations.  That is what happens when you have so many leaning on one side of the boat and it starts to tip over.  Panic ensues.  People will talk about the unwind of yen carry trades and CTAs and vol control funds dumping their positions, but it all comes down to speculators overexposed to the long side, with very little put protection, feeling intense heat as the market went against them in a hurry.  

A look at the COT data as of July 30, when the SPX closed at 5436, a 230 point drawdown from the top on July 16.  Normally, you would see a lot more positions being unwound by the asset managers and speculators, but that's not what happened.  Net longs remained elevated. And dealers remained very short.  

 

 

It will be interesting to see what this coming Friday's COT report shows, which will cover what happened during the selloff from Thursday to Monday.  It should show heavy reductions in the asset managers and small spec long positioning.  

On Monday, and to a lesser extent on Friday, we finally got the put buying that this market needed to at least start the bottoming process.  Given that its really only just starting, and there was so little put buying during the previous days of the selloff, I would expect it to continue througout the week.  

 

Given the massive move higher in vol, and the psychological damage of such a volatile drop, I don't think Monday was the day that we made a V bottom.  Based on previous vol explosions like August 2015 and February 2018, we should see a retest of Monday's lows in the next few days.  Those lows will probably hold, and you can have a 2-3 week rally which would suck in the bulls again, but they will have much less enthusiasm this time, meaning that I doubt you can get back near the July highs anytime soon.  

 

SPX February 2018

 

SPX August 2015

Covered all my shorts on Monday.  Did put on a small long position in SPX and NDX, looking for a gap up and a 1 day bounce.  Which is playing out.  I will likely close out this position today and may even put on a small short position, looking for another move lower this week to retest the Monday low zone around SPX 5120-5140.  After Monday's capitulation and liquidations, the market is now buyable for a trade, on weakness, and will favor a range trading strategy, rather than a bull or bear strategy.  There should be many opportunities on both sides for the next 2 months.  This is the time to make your points and be on your game.  These kind of trading markets don't last for long.  Take advantage of it while its here.

Altered Beast

Just from looking at the intraday SPX futures movements, quick 10 point moves in a few minutes are happening randomly without much volume.  That didn’t happen earlier this year.  The danger in the market is palpable.  This is not your Jan 1 to July 12 market.  Its a different beast.  From a calm creature to a wild, savage one.  An altered beast.  The HFTs are no longer willing to provide a lot of liquidity because the long term buyers are not there to support the market.   This higher volatility is coming off a stretch of very low realized vol, which has bred a lot of complacency in the market.  The vol control funds are near max long exposure, but will be paring their exposure fast as the higher realized vol readings will force risk reductions. 

 

In the options market, you don’t see as much put hedging or short selling as you did in the past.  That means investors now are more naked then ever, similar to levels that were last seen in 2000.  Its uncanny how much this feels like late 1999/ early 2000.  When investors are not well hedged, they are more apt to panic on sustained selloffs.  Emphasis on sustained.  Since these conditions happen during uptrending environments, short selloffs are not met with panic, because of the built in complacency.  The threshold to panic increases, but that also increases the magnitude of the panic when it does eventually happen.  Like the vicious down moves after hitting all time highs in the spring of 2000.  Or even the January to April 2018 convulsions near all time highs.

Investors and traders have been conditioned for the last 15 years that the market almost always goes up.  That bear markets can be scary, but are brief.  And that it always comes roaring back to make new all time highs.  This is what happened from 1982 to 2000.  But what is scarier this time is that unlike the 1982 to 2000 time period where you had massive technological productivity gains, from 2009 to 2024, all you’ve had are small, incremental gains.  The smart phone, data centers: centralizing storage and outsourcing servers, and now pie in the sky AI, have proven to be a drop in the bucket compared to faster CPUs and the internet.  

Most of the gains from the 2009 to 2024 bull market came from higher profit margins due to much lower bond yields, higher valuation multiples, oligopoly rent seeking, regulatory capture, and the government blowing out its budget to increase demand.   Those are not repeatable in the next 15 years unless the government and the population are willing to tolerate high inflation and even more inequality.  Low inflation and repeating the 2009 to 2024 money spew out of the US Treasury and Fed are not mutually compatible.  A 2000 to 2002 style bear market awaits. 

On Wednesday, they got what they wanted.  A Fed that made wholesale changes to its FOMC statement, basically paving the way for a September rate cut.  The market is always ahead of the Fed, sometimes too far ahead.  But unlike the December 2023 pivot, the rate cuts are coming this time.  The STIRs market is most accurate for the next 2 meetings, and beyond that, much less so.  SOFR and Fed funds futures never priced greater than a 50% chance of a 25 bp cut at the next meeting anytime after the December 2023 pivot.  After the weaker jobs claims data and ISM number, its pricing in 32 bps of cuts for the September meeting.  It means that the market expects 25 bps, but thinks there is a 25% chance of 50 bps cut instead.  

I don’t think we sold off yesterday because of weaker economic data.  It just went up too much yesterday on Fed hopes and call buying and that reverses quickly if the long term money isn’t there to support the higher prices.  

Reporters AND traders are always trying to find a reason for a big rally or big selloff.  The big rally on Wednesday was a combination of short covering and anticipation for a bullish reaction to the Fed meeting.   Based on what I have seen on Twitter, the eagerness to call a bottom and to catch a rally is quite common.  That is corroborated by the relatively low put/call ratios throughout this 2 week selloff.  That is uncommon.  And a big warning sign.  As well as the COT positioning data that showed small speculators getting longer into the weakness last week.  Asset managers barely flinched during last week’s selling.  They are usually reducing longs as the market goes lower.  Despite the violent selling, not much has changed regarding postioning and options flows.  Yesterday was the first day where you actually had muted call buying and some more puts bought, but its still not close to the levels seen at the April lows.  

Tape reading is overrated these days because short term patterns have changed from the past.  You never had so much short term options speculation.  Intraday, the tail is often wagging the dog.   Call speculation is driving many of these spastic moves you see these days.  So much of these flows are short term in nature because of the popularity of short term expiry options.  Dealers have to hedge these flows.  When a bunch of OTM calls suddenly get closer to the money during a rally, like on Wednesday, the gamma squeezes are intense, and lead to exaggerated up moves that are not supported by longer term, stickier flows.  So you get payback and vicious mean reversion as the artificially high prices bring in longer term sellers and there is an air pocket underneath.  

Apparently a 270 point SPX selloff over the past 2 weeks wasn’t enough to scare the crowd.  We may need a 400 point selloff from top to bottom to finally see the call buying subside and for the put buying to really pick up.  I will remain max short until I see much higher put/call ratios.  Its tempting to try to microtrade and catch all the short term moves, and to try to avoid drawdowns.  But that often leads to taking profits too early and missing the big sustained moves.  I expect sustained selling for the next few days as we get closer to the pain threshold for the longs.