Yesterday was a session of divergence among the major indices, as the Nasdaq cruised to a solid gain, but the Dow spun its wheels. Impressively scoring its ninth consecutive gain, the Nasdaq Composite rose 0.8%, and also closed at a fresh 52-week high for the fourth straight day. However, outside of tech-land, the blue-chip Dow Jones Industrial Average merely chopped around in a sideways range before finishing unchanged. Trading in the S&P 500 was also indecisive throughout the day, but the index still climbed 0.5%. Both the small-cap Russell 2000 and S&P Midcap 400 indices matched the 0.8% gain of the Nasdaq. Although the Nasdaq settled near its high of the day, the S&P and Dow closed just above the middle of their intraday ranges.
Turnover in both exchanges was roughly on par with the previous day’s levels. Total volume in the NYSE increased 2%, while volume in the Nasdaq ticked 2% lower. In both the NYSE and Nasdaq, trading remained above 50-day average levels. While the increased turnover may be positive for the Nasdaq, which has already broken out, the faster than average pace of trading in the NYSE could be construed as bearish “churning,” resulting from the S&P and Dow contending with resistance of their January highs. Nevertheless, market internals improved slightly yesterday. In the NYSE, advancing volume exceeded declining volume by a solid margin of 3 to 1. The Nasdaq adv/dec volume ratio was positive by 5 to 2.
In yesterday’s commentary, we pointed out that the S&P 500 was testing resistance of its January 2010 high, as the CBOE Volatility Index ($VIX) was coming into major support of its January 2010 low. Because the last such decline in the $VIX preceded the correction that began about two months ago, we suggested such a low reading in the $VIX may be a warning sign to astute bulls. Thereafter, we received an e-mail from a subscriber, suggesting that one way to play the eventual, inevitable correction in the broad market, rather than merely selling short or buying an inverse ETF, was through buying iPath VIX Short-Term Futures (VXX), an ETF that supposedly tracks the movement of the $VIX Index. In theory, this sounds like a good idea because the $VIX could easily form a significant double bottom at its current level. However, one major problem is that VXX has an absolutely atrociously low correlation to the actual movement of the $VIX. This is best illustrated with the following chart that compares recent performance of the $VIX with VXX over the past six months:
On the comparison chart above, notice how the $VIX Index (the top chart) roughly held support of the same level for a two-month period from late October to late December of 2009. This is shown with the horizontal line labeled “A.” Conversely, VXX trended steadily lower during that same period, falling approximately 20%! This is annotated with the downtrend line labeled “B.” Now, the $VIX has merely come into support of its prior low from January 2010 (the horizontal line labeled “C”), but VXX has once again set a sharply “lower low” (see the trendline labeled “D”). Comparing the relative gains of the subsequent rallies each time the $VIX and VXX formed a bottom, one also notices VXX gained only a fraction of the actual $VIX, on nearly every bounce. Though it’s apparently legal to promote that VXX is designed to track the $VIX Index, the chart above is a sorry excuse for even remotely close correlation between the two tickers. Want to see an even uglier chart of VXX? Just for kicks, check out the longer-term weekly chart below. Is VXX going to zero?
All ETFs that invest in futures contracts are bound to show some divergence from the price of their underlying benchmarks, which is due to the necessary, continuous rollover of futures contracts. But because VXX is linked to a benchmark that “rolls” exposure to maintain a short-term focus, returns are typically eroded much more substantially than can be seen in other commodity-related ETFs. To potentially address the problem, there is iPath VIX Mid-Term Futures (VXZ), which has shown a slightly better performance than the $VIX index over the long-term, and much better performance than VXX, but there’s still a very low correlation. As with VXX, VXZ frequently sets “lower lows,” even when the actual $VIX does not. The “percentage change chart” below compares the one-year performance of the $VIX, VXX, and VXZ:
Although The Wagner Daily typically uses technical analysis to focus on ETFs traders and investors might consider trading, today’s issue was designed to bring attention to two ETFs one probably should not consider buying. At the very least, one will now be aware of the potential danger (low correlation) that exists, if the urge to trade the potential double bottom in the $VIX is somehow too great to resist (it shouldn’t be). Our humble opinion, which is all we ever share, is the only possible use for VXX and/or VXZ is strictly intraday trading.
As for the broad market, divergence amongst the major indices is becoming more clear. Because the Russell, S&P Midcaps, and Nasdaq brothers have all cruised to new 52-week highs, there is a lack of overhead supply. As such, it doesn’t take much buying pressure in order for their trends to continue higher. But the Achilles’ heel of the overall market right now is the laggard performance of the Dow Jones Industrials and, to a lesser degree, the S&P 500. Neither index has managed to close above its respective January high, and we’ve begun seeing bouts of “churning” every time the indexes try to move higher. Our overall thoughts going into today remain the same; play the bullish momentum as long as it lasts, but maintain a vigilant watch on open positions, including the use of trailing stops to protect gains along the way. It may also benefit you to remember the stock market has an uncanny ability to do what the least number of participants expect, and at the time that it’s least expected. Following the mantra to trade what you see, not what you think is a good way to make sure you’re on the right side of the market, while also being able to recognize and react to sudden reversals.
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Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to email@example.com.
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