By Chris Ebert

In last weekend’s analysis it was noted that:

The command from the top from now until at least October is as follows for the Bulls:

  • Do not allow the S&P 500 to fall below 2100
  • If it does fall into the 2050-2100 range, bring it back above 2100 as quickly as possible
  • If it falls below 2050 get ready for war – a war we might not win

That’s a direct order!

doldrumsToday – a look at why that all-important 2100 level is likely to make the summer doldrums different this year. Typically summer is a quiet time for the stock market, not unlike the calm winds that often occupy parts of the ocean near the equator at this time of year.

Stock prices can move at any time of year, but in summertime the moves tend to be more subtle. Perhaps the obvious reason for this phenomenon is that many people take vacations in North America and Europe during the summer months, so there are fewer people trading in some of the biggest markets in the world.

There are times in the summer months when it seems as though few if any large institutions are trading; and trading volume gives the appearance that some days are for “retail traders only”. While the absence of large institutions can contribute to stagnation in stock prices (retail traders generally lack the capital necessary to move prices) it can also lead to volatility and wild swings in prices under the right conditions.

If one thinks of the large institutions as the captain of the ship, the smaller retail traders are like the thunderstorm that occasionally interrupts the summer doldrums. Without the institutions steering the ship, even a small storm can blow the ship off course in an otherwise tranquil environment. Even an insignificant bit of economic news can spook retail traders into selling stocks, which drives prices lower. Institutional traders then interrupt their holiday to snap up stocks at bargain prices and that pushes prices back to where they were originally. The ship returns to its intended course.

As it turns out, 2015 may be more prone to these violent retail-induced storms than recent years. The reason the summer of 2015 is likely to be more volatile than usual is that the S&P 500 is in an unusual place right now. It is currently skirting a line known here as the Orange Line of Violence; and that’s something it has not done in the summer since back in the year 2012.

OMS 07-04-15

* see option descriptions below

The Orange Line of Violence is a narrow zone in the S&P 500 which represents extreme stagnation. Only when stock prices do not make any sustained progress – up or down – for several months does the S&P approach the Orange Line of Violence. Obviously, the lack of sustained progress for such a long period of time is bound to cause a buildup of tension.

When stock prices are not enjoying sustained rallies, bullish traders start to wonder whether owning stocks is really a good idea. Bearish traders start to doubt the prudence of shorting stocks when there are no sustained sell-offs. A lack of confidence spreads across the market, and this lack of confidence is particularly pronounced when the stagnation is extreme. Again, extreme stagnation is depicted by the Orange Line of Violence.

So, while recent summers began with the market having a clear direction, the summer of 2015 has no direction to speak of – at least not yet.

  • The summer of 2011 began on the Orange Line of Violence
    That summer saw a violent 200 point sell-off in the S&P
  • The summer of 2012 began on the Orange Line of Violence
    That summer saw a violent rally of nearly 200 points in the S&P
  • The summer of 2013 kicked off with Lottery Fever (euphoric bullishness)
    That summer the doldrums saw the S&P rarely move outside a 50 point range
  • The summer of 2014 again started with Lottery Fever underway
    That summer the doldrums caused the S&P to remain a few points either side of the 1985 level from June through September.
  • The summer of 2015 started almost exactly on the Orange Line of Violence

The list above, by itself is merely anecdotal evidence. However, data going back more than twelve years tends to support the hypothesis that summer trading is more violent (large intraday moves and/or large sustained moves) when the summer season begins with a sense of indecision among traders – which tends to occur near the Orange Line of Violence.

A quality of the Orange Line of Violence that makes it easily recognizable is that it tends to exist near an S&P 500 Temperature of 100. When the Temperature is well above 100 at the start of summer, everyone knows the stock market is hot, and they trade accordingly, albeit at a laid-back summertime pace. Likewise, when the Temperature is near zero or sub-zero everyone acknowledges that the market has cooled off and they change their strategies to suit the coolness, but again at a relaxed summertime pace.

Think of the S&P 500 Temperature as if it’s the water temperature (Fahrenheit) in a hot tub. When the Temperature is at or near 100 it is neither hot nor cool but lukewarm; and folks tend to adjust their trading day-to-day, even while on vacation, resulting in a fickle market with violent moves – quite the opposite of normal summer doldrums. Each time it gets a little above 100 the buying accelerates as fear spreads regarding missing the next breakout to new highs, like folks are piling into the hot tub to secure a seat before all seats are taken. Each time it falls a little below 100 the selling accelerates on fear that the long-overdue correction is beginning, as if shivering folks are jumping out of the hot tub.  As long as the temperature stays near 100, though, each bout of buying and selling is temporary and easily reversed, as if the hot tub is neither alluringly warm nor uncomfortably cool.

SNP Temperature 92

Temperature as of July 4th 2015

If the summer begins with the euphoria of Lottery Fever, traders are less prone to sell their stock positions on every minor pullback. When the summer begins in the Digesting Gains stage, traders are looking for signs of breakouts from each consolidation pattern in which to add to their stock portfolios. When summer begins in the Resistance stage, everyone is looking for a crack in the brick wall of resistance. In each case there is a clear sense of direction, and traders take that sense of direction with them even as they enjoy their holidays.

Indeed, even when summer starts out on a Bear Market note, there is a clear sense of direction – down. When stock prices are struggling in a bearish environment, traders tend to keep an eye out for good economic news. They tend to look for support levels to buy stocks and resistance levels to sell. Even in a bearish environment, the summer doldrums can be relatively orderly and dull.

But, when summer begins on the Orange Line of Violence, nobody knows what to expect. A headline like Greece can send traders into a selling frenzy. Is this the beginning of a Bull-market correction? Or is it just continued consolidation before the next leg up? Nobody knows.

What we do know, from many years of past experience, is that when summer begins on the Orange Line of Violence (at a Temperature near 100) the normally quiet doldrums of July and August tend to be stormy. Whether the S&P hits new record highs this summer, or whether it finally takes that much-anticipated 10% pullback, or whether it ends the summer right where it started – at the 2100 level – it is likely to experience violent turbulence in the interim.

The doldrums of 2015 are likely to be anything but calm.

* Option strategies referenced above are analyzed for profit or loss on expiration day only and are opened using an at-the-money strike price, 4-months to expiration, using options traded on a broad-based ETF such as $SPY (NYSEARCA:SPY)

The preceding is a post by Christopher Ebert, Chief Options Strategist at Astrology Traders (which offers subscribers unique stock-trading perspectives and options education) and co-author of the popular option trading book “Show Me Your Options!” Chris uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. Questions about constructing a specific option trade, or option trading in general, may be entered in the comment section below, or emailed to OptionScientist@zentrader.ca

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