Stock Incubator

[dalcindo]

MEC: FAZ, FAZ vs. $SPX, and FAZ vs. 1/$vix: - Method For Defining A Security's Lowest Risk, Best Market Value, and Timing:

- Dalcindo

Recently, we explained how the Maximum Expansion/Contraction model ("MEC")'s simple charting methodology may help decipher market reversals given a specific security (or a group of sector-related securities/ETFs), caveat being that not enugh time had elapsed to check its reliability as of yet. Howevever, the system remains uncanny and merits continuous, real-time monitoring as the market move forward.

MEC also helped establish a relative value among a group of securities/ETFs. It does so by comparing the behavior of one security/ETF versus that of another when each reacts against a broader market reference (I have used the S&P 500 as a universally-accepted benchmark). In fact, this comparative analysis of stocks/ETFs against one another or each against the $SPX helped use interprete the MEC in terms of predictive market action (expansion vs. contraction), market reaction (probability of rally or decline).

Here is another analytical chart I have prepared today to decipher, and possibly preempt, market moves. The difference here is that I have used a single security (I continue to use our friend FAZ as an example, but any other security should do as well). Hopefully, the complexity should ultimately make sense once I explain the Market Expansion/Contraction (MEC) phases as they relate to the underlying security and overall market action, market psyche and market reaction. For this, I thought to simplify these interactive concepts by adding a self-explanatory visual table at the bottom of this graph.

Regarding the security itself (FAZ), here are additional observations worth noting:
FAZ - FAZ is expressed in three ways:
1 - FAZ Absolute value: Daily value of FAZ expressed as a RED line

2 - FAZ Relative value to $SPX: Note how the absolute value of FAZ compares to its relative value with $SPX. One extrapolation from this simple comparison may be that at the extreme-LOW distance between FAZ and FAZ:$SPX, FAZ reveals to be at its cheapest value compared to its absolute expression, hence offering the cheapest market value opportunity at that specific time.

Similarly, an extrapolation from this same simple comparison may be that at the extreme-HIGH distance between FAZ and FAZ:$SPX, FAZ appears at its highest market value compared to its absolute expression, hence offering the most expensive opportunity at that specific time.

Additionally, discreet changes between the absolute value and the relative strength may provide a relative time value opportunity, such that in a declining market, the increase spacing between the two may herald cheaper market value for that security, whereas the narrowing may herald more expensive opportunities ahead. Conversely, in a rallying market, the increase between the two may herald more expensive opportunities for that security, whereas the narrowing may herald cheaper opportunities ahead.

3 - FAZ Relative value to $VIX reciprocal: When comparing FAZ, or any security/ETF, to market sentiment, the reversal of $VIX is best used, as the original direction of that security and allows for the expresion of the relative strength of that security (i.e.: security x 1/$vix, here = FAZ x 1/$vix = FAZ/$vix). Overall, the abstract representation of the line as a ratio is what results from this simple mathematical expression.

A simple observation of the chart would reveal that FAZ/$VIX has printed a significant double bottom (late NOV 2008 and early MAR 2009) and a recent top (early MAY 2009). A closer look at these two events, when compared to the absolute value of FAZ indicates that when the pair (FAZ/$VIX) reaches a bottom, a support level has been defined by FAZ/$VIX at that level, thus defining a probability of rallying once the absolute security (here, absolute value of FAZ) reaches that bottom. Overall, the security is expressed against market sentiment, such that a topping value indicates a reversal from "smug" to panic, and vice-versa. Similarly, an extreme high would indicate a highly complacent market and high probability for overall reverssal. Here, since we are dealing witha bear directional security, then the expectation would be for that security to rally. Notice how the converse comes true as well.

As this and any other observation made herein is purely empirical, a trading strategy of your own assets should not be determined by this text or any other text in reference to MEC.

MEC: FAZ, FAZ vs. $SPX, and FAZ vs. 1/$vix:


- dalcindo