Ongoing MIDAS Research

This is an update of my March 17 post. It contains new ongoing research on MIDAS curves on independent fractal datasets (including in this post the Baltic Dry Index) and will therefore also be stored in the folder “Ongoing MIDAS Research”.

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A.Coles, March 23 2011

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Summary and Recap

One of several purposes of my last post of 17 March was to illustrate a new use of MIDAS curves on the VIX (ie, MIDAS volatility curves) and the MACD (ie, MIDAS momentum curves). I also raised the question whether there was another new use of the curves in this application, namely:

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Whether breaks of MIDAS support/resistance curves on independent datasets are actually advance warnings of breaks of price-based MIDAS support/resistance curves.

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I’ll further recap on this idea here before expanding it a little for purposes of ongoing monitoring. Later, I’ll also highlight very similar “advance warning” curve behaviour on the Baltic Dry Index to the behaviour on the VIX curves.

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First, let’s recap. Focusing on the VIX in my previous post, I noted in Chart 1 below that the VIX had last week crucially broken two MIDAS resistance curves that had been launched from the March 2009 subprime bottom while also breaking the more recent September 2010 curve.

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Chart 1: VIX with major break of complacency resistance into greater upside volatility (”fear”)

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The obvious question this raised was whether it should be taken as a warning that the corresponding MIDAS support curve (S1) from the same March 2009 subprime bottom would also be tested successfully on US indices (in particular, the S&P 500, DJIA, and Nasdaq 100). If the warning turned out to be correct, this would be another interesting new role for MIDAS curves when they could be plotted in these atypical contexts.

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Subprime S1 on the VIX, the S&P 500, and European indices

As for the S&P 500 itself, we can see from Chart 2 below that at the present time price is some way above the March 2009 subprime trendline as well as the S1 subprime support curve, while (as noted) the corresponding S1 curve on the VIX has been broken.

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Chart 2: S&P 500 with March 2009 subprime trendline and March 2009 subprime S1 MIDAS support curve

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However, support for the idea that the break of the subprime curves on the VIX may be forewarning of the break of subprime S1 on the US indices comes, interestingly enough, from several European indices, where the March 2009 trendline has been broken as well as the subprime S1 MIDAS support curve. For example, the March 2009 trendline has been broken on the DAX and I drew attention to it in my March 17 post (see here).

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However, if we look at Charts 3 and 4 below we can see that the MIDAS 2009 subprime curve corresponding to the VIX has either been well and truly broken or is currently being tested.

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Chart 3: Swiss Market Index continuous futures

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Chart 3 above is of the Swiss Market index futures, where we see the March 2009 subprime trendline broken as well as subprime S1 (last week). Chart 4 below is the futures on the Euro Stoxx 50. Most of our non-European readers will know that the Euro Stoxx 50 is Europe’s leading Blue-chip index for the eurozone, providing full representation of the supersector leaders. Consequently, it’s an important European bellwether complement to the S&P 500. As I write, the March 2009 subprime trendline and subprime S1 have become coextensive on the chart, and the index is testing both simultaneously, albeit S1 has already been broken some months before.

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Chart 4: Euro Stoxx 50 continuous futures

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Space prevents further charts here in relation to the March 2009 subprime trendline and the MIDAS subprime S1 curve, but here’s a summary below in Table 1 of what is currently taking place. As we can see, there’s been some substantial testing of the March 2009 subprime trendline and MIDAS subprime S1 curve.

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Table 1

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Comparison between Europe and US

What Table 1 demonstrates is the relative strength in the US markets as compared to Europe. Measured in relation to the March subprime 2009 trendline and the subprime MIDAS S1 curve, the only European markets to match the  strength of US markets are the DAX and the FTSE 100. Indeed, if we look at the DJ Global Stock Index/Excluding the USA, we see that this index too has tested the March 2009 subprime trendline along with most of Europe.

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*The DJ Greece index has not only broken the March 09 subprime trendline and the subprime S1 curve, it has also broken the actual March 09 subprime support. In doing so, the market has declined in a five wave Elliott impulse and is currently correcting this completed impulse.

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Chart 5: DJ Global Stock Index, Excluding the USA

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Conclusions

1. Volatility in the US options market as measured by the VIX vis-a-vis subprime VIX S1 has been much closer to sentiment in European and other world markets in comparison with the strength displayed in the S&P 500 and isolated European indexes such as the DAX and FTSE 100.

2. In the British financial press over the weekend, much emphasis was placed on the rebounding of global stocks towards the end of last week, with many commentators struggling to explain it. One intermarket explanation for improving risk-appetite was the first coordinated G7 intervention in the currency markets in 10 years to support the yen. Perhaps this did play some part, but it’s clear from the charts, both globally and European, that the brunt of the explanation stems technically from price testing the March 2009 subprime trendline and, in several indices, the MIDAS subprime 2009 S1 curve.

3. Will the breaking of the MIDAS subprime 2009 S1 curve on the VIX provide a genuine warning for what’s to come with regard to the same price-based curve on US indices such s the S&P 500? Time will tell, but as we’ve seen this curve has already been tested on several European indices.

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SHORT ADDENDUM: MIDAS curves on the Baltic Dry Index

If we look at Chart 6 below of the Baltic Dry Index (upper pane) and the S&P 500, we’ll see another application of MIDAS curves to economic time series, this time the Baltic Dry Index (BDI). However, we’ll also see similar MIDAS curve behaviour on the Baltic Dry Index to what we’ve seen on the VIX.

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Chart 6: the Baltic Dry Index (upper pane) and the S&P 500

I’ll write a separate post on the Baltic Dry Index later because its weakness makes interesting reading in relation to open interest on the Commitments of Traders (COT) Report. For now, however, we can see the same phenomenon in relation to the March 2009 subprime low on the Baltic Dry Index as we’ve seen on the VIX.

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The key on this chart is what’s being highlighted by the large blue and red curves on the right of the chart in relation to S1 and R1 on the S&P 500 (green) and the Baltic Dry Index. Notice that at the blue arrows the S&P 500 breaks above R1 but that the Baltic Dry Index fails to do so, with the result that R1 has been a strong resistance curve on the Baltic Dry Index since November 2009. Moreover, at the red arrows S1 acts as critical support for the S&P 500 in the rectangle, but the same S1 from the subprime low on the Baltic Dry Index is broken in March 2010. Since then, (second arrow) it too has become resistance, along with R1 further above it.

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Thus, the question again arises: Is the breaking of S1 from the March 2009 subprime low on the Baltic Dry Index (= the breaking of the same S1 March 2009 subprime curve on the VIX) warning of a similar breakdown of the price-based S1 on the S&P 500? This is a compelling question, because we now have two independent time series (volatility and economic) breaking the subprime S1 curve alongside several European indices.

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This is ongoing work and I’ll update the corresponding ongoing thread in these posts periodically.

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This is an update of my post of 22 February 2011. The second half of this post also contains new material related to an Active Trader (April 2011) article and will be stored in the new folder “Ongoing MIDAS Research” along with Bob English’s chart.

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A.Coles, 17 March 2011

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Summary and update

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The purpose of my Feb 22 post was to warn readers that an important price/time inflection was clearly visible on a number of European and US stock indices and hence to warn of a possible top.

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Prices were rallying hard on Feb 22 when the post was made. Since then, however, the major indices have broken both the 20 day and 40 day moving averages as well as the September 2010 intermedediate degree trendline (ie, 6 weeks to 9 months), indicating that a correction of at least this magnitude is now underway.

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However, on Tuesday of this week the DAX also ominously broke its March 2009 primary degree trendline. Since this trendline originates at the subprime low, this is now of considerable significance and points to the correction being possibly of primary degree proportion (ie, 9 months to two years). However, since a correction of this degree is highly unlikely so soon after a major market bottom in March 2009, the real possibility that must be considered now is that the market is beginning the putative wave C which, according to conventional Elliott Wave theory, has long been predicted on the basis of the relatively clear wavecount on a number of international indices, including China’s Shanghai index. My next post will cover this large topic.

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It’s clear in any case that this was indeed a major inflection point in light of the data that were confirming big related intermarket moves last week. The Reuters Jefferies CRB index was down 2.9 percent over the week, its largest fall since last November, and copper and iron ore were also down 8.6 percent and 6.2 percent respectively. I’ll return to these data too in the next post in relation to some recent MIDAS work on the Baltic Dry Index, which had been warning of the implications of China’s troubles for some time. The flipside of these large moves was haven movement in US Treasuries, gold, and the US dollar.

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The inflection point in price and time

Before saying more about the implications of these major technical breaks on the indices, I’ll quickly recap on why this major inflection point stood out so much on February 22.

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The price aspect of the inflection point was identified by several indicators.First, price was about to test the major downside trendline on Bob English’s long-term detrended MIDAS curve on the DJIA (www.precisioncapmgt.com), which he drew attention to in a privately circulated email. Courtesy of Bob I’m posting the chart here as Chart 1.

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Chart 1

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Second, there was a clear  five wave Elliott Wave impulse completing from the July 2010 bottom accompanied by a very significant negative divergence on the weekly MACD histogram. I posted this chart in my February 22 post and readers can see it here .

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The time aspect of the inflection was identified by the Long Term Delta. For readers not familiar with Delta time analysis, it’s an extremely accurate, almost clock-like, fractal system discovered by the Chicago commodities trader Jim Sloman and then adopted by Welles Wilder, who discreetly publicized it to the fund-management community before later writing a book. It’s vastly superior to standard cycle analysis. The Long Term Delta (LTD), one of several fractal time levels the system identifies, is roughly equivalent to the intermediate-term trend. My solution to the LTD on the S&P 500 was signalling the start of a new cycle barring an inversion. It’s clear now that an inversion did not occur. I can therefore update the LTD by stating that the next LTD pivot is due between early May and mid-June. See Chart 2.

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Chart 2

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It’s not possible to be more precise than this due to the small amount of variance in the system. Readers note: I’m not claiming that a major bottom will be in place between these dates, merely that this is the next significant time juncture on the LTD and that it will affect the market by at least three to four weeks.

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As for price targets, it’s possible right now to launch a bottomfinder on the DAX (as on many other indices) because the displaced move is parabolic. However, I suspect that this will only forecast to the current end of this parabolic move, which I doubt will coincide with the time period forecast by the LTD. The DAX futures are currently being supported at the 6,400 area, because this related to the swing highs created during the March-July 2010 correction. However, this support area won’t last long and I suspect that S1 is a more realistic target. See Chart 3 below. However, note that S1 on the VIX has already been taken out (see below). This might be forewarning of what’s to come with regard to the S1 subprime curve on the indexes.

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Chart 3

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Additional MIDAS tools recently applied to the uptrend between March 2009 and the recent February 2011 top

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I flagged this post as containing new MIDAS work insofar as I have been following this uptrend with several additional MIDAS indicators that don’t contain the VWAP formula upon which MIDAS curves are based. For interested readers, I have an article appearing on this topic in the April edition of Active Trader. The material came too late for the book.

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MIDAS volatility curves on the VIX

First, if we look at Chart 4 below we’ll see three MIDAS volatility curves on the VIX. The VIX is one of the most widely quoted indicators in the popular financial press but it’s hard to understand why technicians haven’t used the volatility data to create more accurate signals. One obvious thing to do would be to run a momentum formula through it to get consistent signals that can measure trends of various durations depending on the lookback period, much like Larry Williams did with the Stochastic to create the COT Index from COT Report data. In any case, creating MIDAS curves from VIX data is one way of creating novel support and resistance fear/complacency signals from the VIX.

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Chart 4

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As we can see if we look at the blue arrow and the large red one on the right, a MIDAS curve has been resisting pullbacks in falling complacency all the way up this uptrend since September 2010 and even before it, since the blue arrow below the large red one highlights that it was possible to launch the MIDAS resistance curve on the VIX in late May, a good month before the S&P 500 bottomed. Indeed, with some porosity the VIX even resisted the volatility (“fear”) associated with this bottom.

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Moving to the far right of the chart, we see that the pullbacks in the recent uptrend since September have been timed extremely well by the VIX MIDAS curves, as they resist pullbacks in ongoing complacency. However, the current February-March decline was resisted on the VIX initially by three MIDAS resistance curves, two coming all the way back from the March 2009 subprime bottom. Again, the fact that this major resistance area in downwards complacency has been taken out has to be taken very seriously.

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Importantly, I notice that the same price-based curves on the S&P 500 are a long way from being tested. Does the breaking of the VIX curves from the same subprime 2009 bottom imply an early warning that the price-based curves will also fail to hold price? Only time will tell. In any case, early warnings of price moves on MIDAS curves plotted on time series other than price would be yet another new use of MIDAS curves. I’ll watch this chart with interest. In due course, I’ll also start plotting MIDAS support curves on the new volatility uptrend on the VIX. See Chart 5.

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Chart 5

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MIDAS Momentum Curves on the MACD

Another chart of interest in relation to the recent Febuary-March top is Chart 6. This chart is also of interest in so far as it’s another example of MIDAS curves being applied to new time series and thus of not containing the VWAP content. The use of the MIDAS curves on the MACD is restricted to times when the MACD opens out and starts trending. It doesn’t always do this, since it will often oscillate fairly rapidly back and forth like a bounded oscillator. See Chart 6.

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Chart 6

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In Chart 6 we see the MACD in relation to the S&P 500. For the purpose of this blog entry, our interest is in the momentum MIDAS curve launched from point (3) on the right. Notice that, like the VIX MIDAS curves, it too was launched a month or so before the actual price low, thus supporting it definitively when it did come. In Chapter 16 of the book I worked with On Balance Volume as the independent time series and called this phenomenon the Dipper Setup, meaning that in divergences you can launch MIDAS curves from time series tops or bottoms to catch the actual price highs or lows rspectively. For decades traders have celebrated the power of divergences to warn of the ends of trends, but have grown weary of trying to time them. This particular application of MIDAS curves is a genuine solution to this intractable problem.

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In any case, the blue arrows reveal how powerfully the MIDAS momentum curve has supported the September intermediate uptrend. However, it too has now been tested successfully in this February-March downtrend, and this too must be regarded as another indication of some significance, since we now have breaks in price, momentum, and volatility. This indeed was an important price/time inflection point.

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MIDAS Curves on Economic Datasets: the Baltic Dry Index

I’ll write a separate post on this.

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A.Coles, March 15 2011

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This entry pertains to the new category “Ongoing MIDAS Research” and will be stored in the new folder on the right bearing this name.

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One of the aims of this site has been to use it as a storehouse for new and ongoing MIDAS research. However, since the site was created, new work on MIDAS has either appeared in articles or more recently in the book. With the book’s completion, we’ve now decided that there’s a need once again to use some area of the site to store new MIDAS work.

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The problem is that the site’s design is based around the blog, which in turn was developed for market commentary. Consequently, there isn’t a facility on the site ideally suited to store accessible research. Storing the information in the blog archives is a problem in so far as anything worth saying in a single blog entry (or as part of a blog incorporating ongoing market commentary) will be quickly submerged in the many other entries that make up the blog. As a result, interested readers – us included – will find it extremely difficult to reference this material later.

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As the design of the site stands, the best way of getting around this problem is to store ongoing MIDAS work in a separate blog category I’ve just created called “Ongoing MIDAS Research”, which readers can see on the right. Accordingly, any new work will be stored in this folder as well as under our own respective names.

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What do I mean by “ongoing MIDAS research”? I mean anything that might fall under the following categories:

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1. Genuinely new MIDAS applications to new datasets. For example, I (Andrew Coles) have an article forthcoming in Active Trader where I’ve created new MIDAS curves based on momentum and volatility data and other fractal datasets such as the Baltic Dry Index and Relative Strength ratios. This goes beyond the book. Work of this nature would be highly relevant.

2. New variations of MIDAS curves as a result of any manipulation of mathematical procedures involving MIDAS.

3. New uses of MIDAS curves. For example, on one particular dataset MIDAS curves have been used as disconfirmatory curves in relation to price-based curves and we’ll be watching the possible significance of this in the coming months.

4. Atypical contexts where for whatever reason MIDAS indicators fail unexpectedly. If they do, we’ll want to know why and we’ll want to explain it thoroughly.

5. Any technical contexts that produce unusual behaviour in MIDAS curves or, on the flipside, appear to work particularly well with the MIDAS approach, resulting in interesting creative and technical synergies.

6. Spectacular successes and spectacular failures involving the curves.

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When we identify one or more of these conditions, we’ll either write a separate blog entry on it, or we’ll incorporate it into one of the market commentary blogs. However, at the beginning we’ll flag the blog entry as involving new MIDAS research and store in the new blog category, “Ongoing MIDAS Research”.

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Finally, there’s a brief apology over the relative infrequency of blog entries here plus on occasion the absence of the richness of MIDAS analysis that can be found in the book and articles. The reason essentially is time. I learned this lesson quickly when I first started frequently posting longer commentaries on here. Extensions of the MIDAS tools unfortunately require a great deal of data- mining and data-manipulation in Metastock, particularly when focusing on areas such as open interest and the creation therefrom of various indicators I discussed in Chapter 12 of the book and of evolved curves such as those that use, say, Open Interest Weighted Price (OIWAP) instead of VWAP. David too has his own time limitations that prevent him from developing many of his own interests to the extent that he’d like to. With this proviso, we’ll do our best to keep the site updated as frequently as we can, both with market commentary and with new MIDAS-based research.

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