The set-up: I am looking for a short-term pullback in the market this week. The Russell 2000 (IWM) and the SPY (SPDR S&P 500) both made new highs on Thursday and started to pull back Friday. The Dow had an intraday new high on Thursday and the NASDAQ closed at a new high.
After having a nice uptrend, the Dow Jones Transportation Average (IYT) pulled back all week. In Dow Theory, in order for the markets to move forward, the transports and the Dow have to move together; last week, we saw them diverge.
What put it on my radar: In a word, gaps. There’s a gap in the NASDAQ that fills at $143.19, and another at $139.96 that fills at $139.23. The SPY has a small gap that fills at $245.74, but down further there’s one that doesn’t fill until $242.57. The Dow has a gap that fills at $214.34. Given the rise in the market and what I saw in market action on Friday, I expect that one or more of these will fill, so I am looking at a trade in volatility.
How I’m playing it: I will start a position in Credit Suisse VelocityShares Daily 2x VIX Short-Term ETN (TVIX) if it comes over Friday’s open of $16.77. I would stop out of that position on a break of $16.43 to the downside. I am looking for this to move up to $19.77 which, coincidentally, is the 20-period moving average.
Why it makes sense: I’m not bearish, I’m just trying to play a short-term reversion to the mean, a normal pullback in an uptrend. When price action on the SPY gets extended from its 20-period moving average, it tends to get drawn back to that level. It’s very stretched now, so I’m looking for that pullback.
Petra Hess runs PetraPicks.com. She is a technical swing trader and long-term investor in domestic and Canadian stocks. She only trades stocks, not options. At the time this article was published on RagingBull.com, she did not have any shares or open orders in TVIX, nor in ETFs covering the indexes mentioned, but she is considering TVIX for trading today as described in this commentary.