LunaticTrader

Investing with the Moon

SKEW is high again

Posted by Danny on March 20, 2017

Stocks have been pulling back a bit in recent weeks, but so far it seems to be the “short and shallow” variant as described in my most recent post. The Nasdaq has easily held above 5800 and is already pushing back towards its recent highs. This means the scenario for a further 5% surge before summer stays firmly on the table and is gaining traction. Let’s have a look at the current S&P 500 chart:

^SP500 (Daily) 6_17_2015 - 3_17_2017

The trend line since the November lows is being tested but holds up well. The Earl (blue line) has bottomed out and is headed higher, this is short term bullish. The slower Earl2 (orange line) has a bearish divergence in place and that is a medium term warning sign. The MoM indicator is back in the neutral zone and can go either way. The bearish divergence in the Earl2 indicates a serious risk for a significant pullback, but it would get invalidated if the Earl2 turns back up near the neutral line. That would probably happen if the S&P 500 climbs above the March 1 highs. So, what will it be? This is the kind of situations where keeping an eye on investors’ mood is most important.

Right now lots of technical traders probably see a strong potential for a sharp pullback if the blue trend line gives way. And that’s why the CBOE SKEW index reached a new all time high last Friday. This means traders are overpaying for “crash insurance”. But, as I pointed out in this article a few years ago, major crashes are typically preceded by a period of relatively low SKEW readings. When there is widespread confidence and feel-good about the economy then people don’t buy crash insurance puts. Then SKEW becomes low and complacence high. But that’s not what we see at the moment. Here is a chart showing the recent years evolution of SKEW index:

SKEW

The early 2015 highs were accompanied by relatively lower SKEW values for months and that’s when we got some significant drops later that year. Then SKEW reached new record highs in the days before the Brexit referendum, as investors were buying crash insurance again, but most of that crash insurance became worthless as the market surged to new highs in the ensuing weeks. More often than not overpriced cash insurance does not pay off. But bears keep trying and now we have record high SKEW again. Will their crash bets pay off this time? If history is a guide then the answer is: probably not.
And in that case we can expect something like this:

spw

On a breakout above the March 1 highs the market will probably head for the upper boundary of its trend channel (blue) since the early 2016 lows. That boundary is currently in the 2500-600 area, so that would be my initial target for such a move.

This bullish case would go on the back burner if the S&P 500 makes a close below 2350. Such a failure could come this week, because our LT wave for March suggests weakness until the 29th. If no downside action is seen and the bullish scenario can survive this weaker period then we are probably headed for a mad April. Be ready.

2 Responses to “SKEW is high again”

  1. humble1 said

    more terrific work. none better.

    • Danny said

      Thanks for the thumbs up.
      But let’s not forget that every approach goes through its good and bad periods. Market has been smiling on my calls in recent months, but that will not go on forever. I will make my fair share of bad calls too, not deliberately but inevitably…

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