Relative Blahs

• Posted by Adam Warner
• on July 29th, 2009

I have RSI(2) set as a default on Stockcharts, so generally when a pop a chart up on these pages, it is included. But of course, did not actually notice the unique string of readings over 90 the past couple weeks in the SPX. This from Michael Stokes at MarketSci Blog.

The S&P 500 has traded 9 days in a row at an extreme RSI(2) reading over 90. Unfamiliar with RSI(2)? Read more here and here.

Echoing Rob Hanna at Quantifiable Edges, extended overbought readings like this were much more likely in the last century when the market was momentum-driven (i.e. up days tended to beget more up days), but are a rarity in today’s mean-reverting market (read more).

Prior to this month, this century had only seen one instance of a 7-day RSI(2) run over 90 – we’re now at 9-days and counting.

Where does the market go from here?

 

Now as you can see from the chart, the streak ended. Of course the logical inference was that we got overbought and we’re going lower. As always though, not quite that simple.

All indicators can emit signals, and then go further. As Michael would point out, you’d get bearish too early following this one religiously. Of course in hindsight we’ll be able to point to this as a red flag that the market went too far too fast.

And remember that big futures premium in the August VIX? It’s all but gone now, or at least levels that are not terribly significant in a vacuum. We’re under 2 points now which is as much margin of error as anything as the VIX is never perfect to the penny.

What’s most interesting is that the premium resolved not with a market melt or a volatility explosion, but simply a meeting in the middle. The VIX lifted a couple points and the futures have drifted lower. There was not much path to profitability here as the only way to “buy” the VIX is to buy VXX or VIX futures or calls. And they all declined. And owning actual volatility (say SPX or SPY straddles/strangles) didn’t work well either as realized volatility of the underlying remains under implied options volatility.

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