Obviously the keys to long-term success involve proper position sizing, risk management mechanisms, and ultimately leveraging probability. Professional traders are masters of these tenets. These characteristics are what separate successful traders from average traders over the long haul.

Sometimes through my rigorous analysis I come across price charts and oscillators that help put together a picture that helps shape my view of the marketplace. The past few months have been some of the most difficult market conditions that I have seen in some time.

The “wall of worries” permeates the financial landscape as risk at present seems unprecedented. The list of macroeconomic concerns ranges from the European sovereign debt crisis to escalation of military action in the Middle East.

I could probably write an entire article about the various risks that plague global financial markets at present, but I try to focus on the positive in any situation. Right now remaining optimistic is a daily battle amid the constant barrage of depressed economic data. Instead of focusing on all of the various risks, I focus on finding opportunities where probabilities are favorable based primarily on historical price data, cycle analysis, and tape reading.

Back on April 9th I proffered an article that discussed my expectation that the U.S. Dollar Index would rally while risk assets such as equities and oil prices would collapse. Additionally I commented on my expectations for weakness in gold, silver, and the entire mining complex. I was wrong about the timing of the U.S. Dollar’s advance, but the ultimate price action analysis was correct.

The following quote came from that article, “As shown above, I believe that short term targets to the downside are likely somewhere in the 1,475 – 1,525 price range. I think gold will find a major bottom near these levels and a strong bounce will play out.” (Click here to view the entire article)

When I originally wrote that article referring to a decline in gold prices gold futures were trading around 1,630 an ounce. Price rallied sharply higher after my article went public, but fast forward to today and my concerns appear to be well founded. I am a long-term gold bull and I ultimately believe that new highs will occur in the future. However, gold and gold miner’s may have further to fall before they find major support.

As stated above, my original expectations for the Dollar Index did not happen in the time frame I was anticipating. However, the belief that a rally was forthcoming proved to be accurate as can be seen from the price chart of the U.S. Dollar Index shown below.

U.S. Dollar Index Daily Chart

Traders Video Analysis Chart

As can be seen above, the price action is confirming serious strength. The weekly close on Friday saw the Dollar close above a key short-term resistance level. Additionally I would point out the double bottom that has been carved out on the chart above which is also bullish. Should resistance near 80.76 give way to higher prices a test of the recent highs is quite possible.

The technical picture suggests higher prices in the near term for the greenback. From a fundamental  viewpoint, recent economic data also suggests that higher prices may await as one the largest weekly debt issuance of 2012 among sovereigns within the Eurozone will transpire next week. If any of the debt auctions go poorly it will reflect negatively on the Euro currency and help push the Dollar higher.

Most of the debt issuance is outside of the 3 year maturity window so the LTRO justification to encumber risk does not apply. Next week we will find out just how serious investors are about accepting default risk on European debt instruments. I would be shocked if the ECB sits idly by, but the sheer amount of capital required to safeguard debt issuance next week is extreme, even for a major central bank.

The Euro currency continues to fall and has broken key resistance around the 1.30 price level on the EUR/USD currency pair. Price is not collapsing as of yet, but we are seeing a slow and steady slog lower for the Euro. This price action serves to boost the Dollar which ultimately places downward pressure on risk assets such as equities and oil. Additionally, it reduces the valuation of gold. The daily chart of gold futures is shown below.

Gold Futures Daily Chart

Gold Trading Video Chart

The recent price action in gold has been quite ugly and price is resting at key support stemming from an intermediate-term descending channel shown above. Should the lower bound break to the downside a sharp move lower could play out.

It is important to remember that gold is coming off a monster multi-year bull run and it only serves to make sense that a nasty pullback that shakes out the bulls would be forthcoming. I continue to believe that strong support and buyers will come back into gold around the 1,450 – 1,550 price range as significant long-term support levels should hold up prices. The key support zone is clearly illustrated in the chart above.

I continue to wait for price to reach that key support level and based on the current proximity those support levels are magnetizing price toward them. When long-term support / resistance levels are near price a test is a common occurrence. The most important question to ask is whether the support zone shown above will hold, or will even lower prices ultimately play out?

Gold and silver both are starting to become oversold on the daily time frame. While the gold bugs have been feeling pain the past few weeks, the gold miners have been taken out back to the woodshed for a good whipping. The miners have been absolutely crushed in 2012 .

My long term analysis revealed something quite extraordinary on the longer term weekly chart of the HUI gold mining index which I believe is critical for readers to watch and monitor. We are nearing valuation levels based on the true strength index that have not been seen since the market crash that took place back in 2008. The weekly chart of the gold bugs index is shown below.

Gold Bugs Index Weekly Chart

Gold HUI Trading Video Chart

 
As can be seen above, the Gold Bugs Index (HUI) has been under considerable selling pressure since early September of 2011. However, note how low the True Strength Index is based on 5 years of price data. We are nearing the same level that we saw back in 2008 which marked a major bottom that ultimately resulted in a monster move to the upside for the gold miners.

I am of the opinion that this chart demonstrates quite clearly that a great buying opportunity for gold, silver, and the miners is likely going to present itself in the near future. I will be watching this price relationship over the next few weeks waiting for a strong entry point for a longer-term purchase. After this pullback concludes, the potential returns that could occur in gold, silver, and the miners could be breathtaking.

With 3 clear support levels, a defined risk approach could be used in order to scale in or to reduce market risk should prices continue to move below each support level. While the time is not right just yet, more than likely a solid long-term risk / reward trade may very well present itself in the precious metals and mining space. I am likely a bit early, but the ultimate end game as it relates to fiat currency is documented throughout history. The final result has a finality that few truly comprehend.

Happy Trading and Investing!

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

Another key development in equities price action as of late has been selling pressure in Apple (AAPL). A few weeks ago we witnessed a sharp downturn after prices surged higher into a blowoff top. Earnings came out and prices jumped again and we have watched Apple’s stock price drop considerably since.

Friday saw sellers circling the wagons pushing the tech behemoth down around 2.25% as of the scribbling of this article. When AAPL was rallying it helped the Nasdaq Composite and the S&P 500 grind higher. Now that it has clearly given up the bullish leadership role, it now appears to be a drag on the price action of domestic indices.

Additionally there was a mountain of economic data released out of Europe overnight which was entirely negative. Spain, Italy, France, Germany, and the Euro-area in general saw their Service PMI readings all come in below expectations. Europe is moving into a recession which whether economists want to acknowledge it or not has implications on domestic U.S. markets. The Eurozone as a whole is the largest economy in the world. Clearly the European economy is slowing, and our exports to Europe will slow as well.

This leads me to the final data point which is still unknown. What will the outcome of the French and Greek elections over the weekend mean for the Eurozone’s geopolitical ties as well as the potential impact on the Euro currency itself?

The answer to that question will likely not be known until late Sunday evening; however by the time U.S. markets open this coming Monday the cat(s) will be out of the bag. This final question leads me to the real topic of this article. The question I want to know is what impact these elections could have on the value of the U.S. Dollar Index as well as gold?

As an option trader, I am always focused on the volatility index (VIX) as well as implied volatility on a number of underlying assets. I came across the following chart courtesy of Bloomberg which appeared in an article posted on zerohedge.com. The chart below illustrates the differential between European Union equities’ implied volatility levels and the EUR/USD currency pair.

Chart Courtesy of Bloomberg

It is rather obvious that EU stocks and the EUR/USD implied volatility levels have diverged. Generally speaking, when volatility increases it means that price action will typically move lower. The higher levels of volatility, the lower the price the underlying will move. There are exceptions to that rule such as earnings reports or key headlines which drive volatility higher, but generally speaking high volatility levels correlate with uncertainty and risk.

What is particularly troubling about the chart above is that the EUR/USD currency pair is seeing reduced implied volatility. This essentially means that the market is not expecting any major moves in the currency pair amid all of the poor economic numbers coming out of Europe.

For those not familiar, the EUR/USD currency pair reflects the value of the Euro against the Dollar. Thus, if the EUR/USD is rising, this means that the Euro is moving higher against the Dollar. The opposite is true when EUR/USD is selling off.

At present implied volatility levels are quite low by comparison to European equities. The zerohedge.com article entitled “Is EURUSD Volatility About to Explode?” shares the following statement to readers, “The last two times this has occurred (in the last year), EURUSD implied vol has rapidly caught up to equity’s risk.”

What that statement means is that it is becoming more likely that implied volatility of the EUR/USD currency pair is going to increase back in par with European stocks. If that takes place, which based on recent data is likely, the intraday volatility in the EUR/USD will increase thus intraday price ranges and sharp moves will become more prevalent.

The long story short is if implied volatility picks up in EUR/USD then it is likely going to be quite beneficial to the U.S. Dollar. The largest concern for Fed Chairman Ben Bernanke has to be the potential for a monstrous move higher in the U.S. Dollar should an unforeseen event arise in Europe. An event such as a disastrous auction or the discussion by German Parliament about leaving the Euro could both help push the Dollar much higher than anyone expects.

A higher Dollar is negative for risk assets and Mr. Bernanke does not like the word deflation at all. None of the central banks around the world like deflation because it means all of the debt they are holding and helping to prop up has a much more significant intrinsic value. If the Dollar is worth more, Dollar denominated debt is also more expensive to pay off.

The U.S. Dollar Index has languished for several weeks, but recently the greenback started to reverse higher and at this time has managed to push above major resistance levels overhead on the daily timeframe. The daily chart of the U.S. Dollar Index is shown below.

If the Dollar remains firm into the bell on Friday which appears likely, the results of the two key European elections over the weekend could provide the ammo needed to really force the U.S. Dollar higher or lower depending on market sentiment. It appears the Dollar wants to go higher currently, but a sharp reversal is not out of the question.

The key level to watch is the 80.76 price level on the U.S. Dollar Index futures. If that level gets taken out, the Dollar could extend to recent highs and beyond should the situation in Europe begin to unravel.

If the Dollar surges what will that mean for gold? Generally speaking most readers would expect gold and silver to move lower on Dollar strength. For a time, that would likely be true, but if a real currency crisis plays out gold and the Dollar might rally together as citizens would try to move their wealth into safe, liquid assets.

Under that type of scenario, gold and silver could both rally along with the Dollar. When the moment finally arrives where the Euro begins to selloff sharply, physical gold and silver will be tough to acquire in Europe.

In the short to intermediate term, gold will likely continue to drift lower searching for a critical bottom. The weekly chart of gold futures below demonstrates the key support and resistance levels that may have to be tested before a major reversal can play out.

Make no mistake, I remain a gold bull in the long term. However, in the short run the Dollar has the potential to outperform gold under the right circumstances. Ultimately it is important to recognize the distinction between selling pressure and what would likely happen in a full blown currency crisis in Europe which is possible, if not ultimately inevitable.

The price action over the weekend on Monday will likely be telling and we could see the beginning of a major move in a variety of underlying assets depending on the election results. Clearly times have changed when U.S. market participants are concerned about what is going on in Europe more so than domestic issues. Unfortunately, we live in very strange times.

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

Recently I have been advising members of my service to be cautious as the market appears to be at a major crossroads. The U.S. Dollar Index is on the verge of a major breakdown. If a breakdown occurs it will be clear that the Federal Reserve will have officially stopped any potential rise in the U.S. Dollar. Over the past few months the Dollar has been producing a series of higher highs and higher lows, however the current cycle may break the pattern as can be seen below.

If the U.S. Dollar pushes down below the recent lows and we get continuation to the downside, we will break the recent bullish pattern. Furthermore, if the Dollar starts to weaken it should benefit equities and other risk assets such as oil. Higher energy prices would not be long term bullish for equity markets so there is concern if the Dollar really starts to extend lower.

However, if the Dollar finds a bottom and rallies it clearly would create a headwind for equities. We should know whether we have a major breakdown on the daily chart in the next few weeks. Until then, the Dollar could go either way and obviously the price action in the Dollar will have a major impact on risk assets and stock market returns in the near future.

From a macroeconomic viewpoint, risk assets such as the S&P 500 Index could be in trouble in the months ahead. U.S. gross domestic product (GDP) came in lower than expected with revisions likely in the near future. Unemployment claims appear to have bottomed and are rising week after week even though the major media fails to report it appropriately as it would appear that the Bureau of Labor Statistics has stumped media pundits with data revisions.

Additionally, there are two other macroeconomic data points which need to be mentioned. The Citigroup Economic Surprise Index has moved below zero and is showing a negative reading. This index is generally a leading indicator regarding equity prices and the recent decline shown below is problematic for the bullish case.

Chart Courtesy of Morgan Stanley

As can be seen above, fundamental data is starting to skew towards the downside which is likely a result of the recession that is in the process of developing over in Europe and potentially in China. Time will tell if the index can reverse, but the bulls need to see a major reversal in the near future.

The chart below illustrates the relationship between metal prices and industrial productivity. Demand for metal increases when economies are expanding and prices generally contract when economies retract. The chart below demonstrates global metal demand. The chart speaks for itself.

Chart Courtesy of Morgan Stanley

Clearly if industrial production contracts (reduction in Global Manufacturing PMI) the impact on the global economy will be felt across multiple countries’ economies. The chart below illustrates the MSCI World Index compared to global manufacturing PMI. Similarly to the chart above, this chart also tells a significant story about what investors and traders should expect if the PMI numbers come in light   against expectations.

Chart Courtesy of Morgan Stanley

As quoted from the zerohedge.com article entitled What do Metal Prices Tell us About the Future of the Stock Market, “In other words, for those who still believe in logical, causal relationships (even in a time of ubiquitous central planning) unless something drastically changes to push fundamental demand of metals higher, one could say the the outlook for equities is not good.”

Essentially, the data shown above is certainly not bullish in the intermediate to longer term. However, it generally takes time for macroeconomic data to permeate all the way through to equity markets. For right now, the story regarding global growth is at the very least questionable based on the data illustrated above.

In the short term anything is seemingly possible. The S&P 500 Index closed above the key 1,400 price level on Friday. I would not be shocked to see prices extend up to the recent highs near 1,420. Ultimately I think we are in a long term topping formation that might require another higher high up to around 1,440 before we see a deeper correction.

The past few weeks have produced a very mild correction compared to the monster rally we have seen since October of 2011. This is a bullish signal, but we need to see prices continue higher and climb a serious “wall of worry” that is coming out of a variety of places. The European situation continues to worsen overall and we have lower than expected GDP numbers in the US paired with concerns about growth in China.

The S&P 500 has some negative headlines to deal with, but so far it has been able to shrug off poor economic data and we could see an extension higher that would shake out the shorts and run stops above the recent highs. However a move lower remains possible. The daily chart of the S&P 500 illustrates the recent correction and the 1,420 highs.

I believe that the next few weeks are going to be critical and the S&P 500 may trade in a consolidation zone between recent lows and the 1,420 highs while traders await more economic data. Fundamental data is starting to indicate that a slow down may be beginning. In contrast, the topping pattern that we appear to be carving out may require higher prices to suck in more longs before moving into a deeper correction.

In the short run, the Dollar will likely hold clues regarding the immediate future for risk assets. However, the longer term picture for equities is quite murky based on the economic data points we are seeing paired with additional concerns stemming from the European sovereign debt crisis. Right now I am looking at time decay based strategies in the near term and will likely stay away from directional biased trades. I would urge readers to be cautious regardless of which direction they favor.

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

Fast forward to the present and hardcore gold bugs remain transfixed on the idea that precious metals must rise. The gold bull market has ended, at least for now and those still holding the bag are looking at large losses from the all time highs set back in 2011.

These same gold bugs will cite a litany of reasons why gold should be moving higher from the unprecedented printing of money by global central banks to the deficit spending and eventual fiscal day of reckoning facing most Western nations. I do not disagree with the gold bugs that in the long run gold prices will rally above the all time highs, but in the short to intermediate term there are several forces which have the potential to drive gold prices lower.

Gold prices cannot rise continually,regardless of the macro-economic backdrop. Nothing, not even Apple Computer (AAPL) or Priceline.com (PCLN) will rise forever. Eventually prices will come back down to earth and revert to the long term mean. It has happened in gold and it will happen to Apple Computer and Priceline.com at some point in the future, it is simply a matter of time.

Before I discuss my reasoning as to why gold and silver are likely to pullback in the intermediate term, I need to remind readers that I remain long-term bullish of precious metals. While the long-term remains bright, the short-term is especially murky and dark.

The first primary concern for gold bugs should be the price behavior of the U.S. Dollar Index recently. The Dollar has rallied sharply higher after carving out a higher low on the daily chart (bullish). The Dollar is on the verge of breaking out above a major descending trendline on the daily chart. Once that breakout to the upside has occurred it will become likely that the recent highs will be tested and possibly taken out. The daily chart of the Dollar Index is shown below.

Dollar Index Daily Chart

The U.S. Dollar’s price action shown above is not indicative of bearish expectations. In fact, I would argue that the Dollar is, and likely will remain in a bull market in the short and intermediate time frames. However, it is important to recognize that strong periods of volatility will persist as Ben Bernanke and the Federal Reserve will continue to try to break the Dollar’s rally as it tries to grind higher.

The Federal Reserve hates deflation, and a stronger Dollar will push risk assets like equities lower and right now that is not part of the Federal Reserve’s election playbook. QE III will likely be announced at some point in the future as an attempt to break the Dollar’s rally and to put a floor underneath stock prices.

The Federal Reserve has used QE I and QE II to help prevent economic disaster. Recently “Operation Twist” has also been used to increase liquidity while keeping the bullish game going. Low interest rates and additional easing adjustments have staved off disaster before and they will likely be utilized again by the Federal Reserve.

Ultimately the free market and cycles will exert their will and the Federal Reserve will be left helpless. The day where monetary easing has no major impact is coming, but we are not quite there just yet.

In addition to the strength in the Dollar Index, the gold miners have been under major selling pressure. In fact, the gold miners have recently broken down out of a major consolidation zone that will likely lead to lower prices in the near term.

Unless gold miners can regain the breakdown level on a major reversal this coming week, the most we can hope for is a backtest of the support trendline sometime in the near future once the miner’s become significantly oversold. The weakness in the miners is just another example as to why lower prices for gold appear to be likely in the short to intermediate time frames. The weekly chart of the gold miners ETF is shown below.

Gold Miner’s (GDX) Weekly Chart

The gold miners are likely to lead equity markets lower in the near term, but lower prices for gold miners is certainly not positive for gold either. Obviously there are several economic factors which could still see gold prices working higher such as a collapse of the Eurozone, however at this moment the likelihood of that outcome in the short to intermediate term is not likely.

The European Central Bank and the Federal Reserve are not going to give up that easily. The process of admitting defeat will take time and global central banks will print money until they feel they have papered over the issue. It is the culmination of either QE III or other monetary easing around the world that will eventually move gold back above the all time highs. Unfortunately the short term price action of gold will most certainly remain under selling pressure barring any major unexpected announcements. The daily chart of gold futures is shown below.

Gold Futures Daily Chart

As shown above, I believe that short term targets to the downside are likely somewhere in the 1,475 – 1,525 price range. I think gold will find a major bottom near these levels and a strong bounce will play out. For long term buyers, I would take advantage of the forthcoming pullback. However, I would be mindful that further selling is quite possible before gold finds a major bottom.

As I said before, the longer term is bright for gold. However, the short to intermediate term will likely see more selling pressure. Until either the Dollar tops or some form of major quantitative easing is announced, I would anticipate lower prices in the yellow metal.

In the near term gold does not look attractive, but the longer term the catalysts for a major move above recent highs are present. The real question has become when and where will the Dollar top? When the Dollar tops and gold finds a major bottom, the potential for a monster move higher will become likely.

Until then, risk remains high.

Jw Jones

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

The view from my turret is ruled by the three primal forces of options — time to expiration, price of the underlying, and implied volatility. Consider for a moment the fact that each of these factors can independently impact a given option.

Multiply this by several available expiration dates and strike prices; add in the fact that individual option positions can include a variety of short and long positions at different strikes and expirations, and the potential combinations that make up an option position in a single underlying can approach a very large number.

For those traders first beginning to navigate this unfamiliar world, I think it is important to understand trade selection is manageable. There are certain families of trades that are unified by similar characteristics.

It is important to become familiar with the various trade constructions available to the knowledgeable options trader. Grouping the potential trades into related groups dramatically reduces the number of trade setups you must consider before entering a new trade.

If you are familiar with the various trade constructions, it makes discussion of a specific family member whom we may consider for employment in a trade far easier to understand.

Description of the family characteristics will take a little time, but it forms the framework on which we can hang the individual trades we will discuss in future postings.

I want readers to begin to become familiar with these patterns because it is these families of multi-legged option trades that we will return to on a regular basis to consistently perform for us.

Let me begin discussion of the various families by pointing out the redheaded stepchild of the trade constructions available. This family member, the single-legged position of being long either a put or call, is not completely without utility.

The reason for its seldom use is that for the knowledgeable options trader, this position rarely represents the best risk / reward structure given the variety of available trade constructions.

One basic and important family is that of the vertical spread. We will return several times to this family not only because of its utility in its basic form, but also because these spreads form the basic building blocks for more advanced spreads such as butterflies and iron condors.

The basic vertical spread is constructed by both buying and selling an option of the same type, either puts or calls, within the same expiration series. This is a directional spread with one breakeven point that reaches maximum profitability at expiration or when the spread has moved deep in-the-money.

It has a defined maximum profit and defined maximum loss when established. The spread is used to trade directionally in a capital efficient manner and largely neutralizes impacts of changes in implied volatility.

There are four individual vertical spread family members — the call debit spread, the call credit spread, the put debit spread, and the put credit spread. Each has its distinct and defining construction pattern. These are not the only names by which these spreads are known. Trying to keep independent option traders confined to a single set of terminologies is like trying to herd cats — it is not going to happen.

For this reason, the additional confusing and duplicative names for these spreads include bull call spread, bear call spread, bear put spread, and bull put spread. To make matters even more confusing, traders often refer to “buying a call spread” or “selling a put spread.” This multiplicity of names for the same trade structure is mightily confusing to those getting used to my world.

I am a visual learner and find that a picture is worth well more than the often cited thousand words. When I review in my mind the various option families available to use in trade construction, I think of the characteristic family portrait of each as displayed in the profit and loss, or P&L, curve.

Attached below is the first in our series of family portraits, but remember within this framework is abundant room for individual variation.

This particular example is a call debit spread, a bullish position in Apple (AAPL).

We will see trades displayed in this format with many variations as we meet the different families. The solid red line represents the profit or loss at expiration. The dotted line represents the P&L curve today and the dashed line the curve halfway to options expiration from today.

In future articles I will discuss other trade constructions that are regularly employed by experienced option traders. Until then, be sure to manage your risk accordingly.

In 2012 subscribers of my options trading newsletter have won 12 out of 13 trades. That’s a 92% win rate,  pocketing serious gains with the trades focusing only on low risk credit spread options strategies.

If you are looking for a simple one trade per week trading style then be sure to join www.OptionsTradingSignals.com today with our 14 Day Trial

JW Jones

And if you look alive, you’ll be singled out and tried.

If you take home anything, let it be your will to think.

The more cynical you become, the better off you’ll be.

Something to believe in.”

~ The Offspring, Something to Believe In ~

The recent rally has been breathtaking, however the majority of investors have missed out on a large portion of these gains as significant levels of cash have been either moved to bond funds or taken out of equity markets consistently during this rally. Let’s face it, financial markets around the world are not what they once were.

U.S. equity markets in particular are manipulated by high frequency trading which is wreaking havoc in the marketplace in terms of potential short term volatility expansions and “flash crashes” that can be isolated to one underlying stock.

In addition to the high frequency trading robots, the Federal Reserve is equally involved in the direct manipulation of financial markets through record easing adjustments. The Federal Reserve has unleashed massive amounts of liquidity while keeping interest rates incredibly low which has produced an environment where the risk-on attitude permeates the landscape.

As a basic example of the failure of recent Federal Reserve policies and their impact generally on the valuation of various underlying assets, I submit for consideration to readers a 20 year price chart of the U.S. Dollar Index.

 20 Year U.S. Dollar Index Chart

It boggles the mind to consider that Chairman Bernanke routinely denies that the Federal Reserve has failed to maintainwhat he calls “price stability.” When looking at the chart of the valuation of the U.S. Dollar against a basket of foreign currencies, most 5^th graders if given the context would proclaim that the Federal Reserve has failed in their objective to maintain price stability.

As time passes and the financial crisis moves further into the rear view mirror, average Americans have varied views about the economy, the stock market, and trust in their government. For most Americans, the stock market does not make sense because they view the stock market and the economy as the same thing. Sophisticated investors understand that stocks and the economy are two totally separate issues, particularly with the amount of manipulation that has been taken place since 2007.

This manipulation has not gone unnoticed by the average American. Now more than ever regular people are not only distrustful of domestic financial markets, but they do not trust Wall Street, and for good reason. In light of this, data compiled during the recent uptrend suggests that retail investors have been pulling money out of equities for weeks even though prices continue to move higher. The chart shown below courtesy of ZeroHedge.com illustrates the recent trend.

U.S. Domestic Mutual Fund Flows

The chart above shows the price of SPY represented as the black line and equity fund inflows/outflows as the red area. As can be seen above, retail investors have been pulling massive amounts of capital out of equity based mutual funds over the past few months as equity prices have rallied. The retail crowd, commonly referred to as sheep or courtesy of Goldman Sachs “muppets,” are selling into the rally.

So why is the retail crowd selling? They do not believe that this rally will last because the real world around them is arguing in the face of everything that this rally stands for. Gasoline prices are crippling the lower and middle classes further reducing their disposable income. Higher food and energy prices paired with job scarcity and serious concerns have begun to mount.

The average retail investor believes the game is rigged at this point and the everyday investor is only helping Wall Street bankers fund their lavish lifestyles. Ultimately, the retail crowd likelybelieves that the only way to win the game is to simply not play.

Will time prove the supposed sheep wrong? Statistically one would think so, but in this case the retail folks may just be right. Headwinds surround the global macroeconomic landscape. Europe is moving into a recession which is being exacerbated by austerity measures. Data came out yesterday (Thursday) that the PMI in several European countries and China contracted. Ireland missed growth targets and central banks around the world continue to print unprecedented levels of fiat currency as if printing money and creating more debt will solve a debt problem.

All of these issues are concerns, but ultimately price is the final arbiter in the world of flickering ticks. From these eyes there are two possible outcomes for the price action in the S&P 500. The first outcome which I believe is more likely is a test of the 2011 highs which results in a snap-back rally that takes us deeper into the 1,420 – 1,440 resistance zone. The chart below demonstrates the bullish potential outcome.

SPX Bullish Outcome

Price action at some point will backtest the 2011 highs and the reaction at that point will be critical. Generally speaking price action does not break a key support or resistance level on the first attempt. Usually the 2^nd or 3^rd attempt will result in a break of a key support / resistance level.

In this case, a test in coming days would likely result in a bounce and reversion to the previous trend. A possible, albeit unlikely outcome would be a break below the 2011 support zone which would then come close to triggering a trend change. The daily chart below demonstrates the bearish potential outcome.

SPX Bearish Outcome

I do firmly believe that the U.S. Dollar Index will hold clues about the future for the price action of equities. According to cycle analysis, the Dollar should come into is daily cycle low sometime in the next few weeks, if not sooner.

From that low, we should see another move higher for the Dollar Index which I anticipate will test the recent highs near 81. The daily chart of the U.S. Dollar Index futures is shown below.

U.S. Dollar Index Futures Daily Chart

If my expectations are somewhat accurate, the short term weakness in the Dollar will assist stocks and risk assets in a move above recent highs. In the case of the S&P 500, a move to key resistance at 1,420 – 1,450 could occur.

Readers should keep in mind that weakness could be disguised as just a consolidation near the 20 period moving average which has occurred in the past when analyzing the Dollar Index. However, I would not rule out one more leg lower before the Dollar finds a bottom.

Gold, silver, and the miners have been under selling pressure for some time and are likely due for a bounce to the upside. The weakness in the Dollar discussed above would allow precious metals and miners to work off some of the short term oversold conditions that we are seeing presently. The daily chart of gold futures is shown below.

Gold Futures Daily Chart

After a move higher into or around the $1,700 / ounce price level for gold, I believe that another leg lower will be quite likely.

Conclusion

Readers should be mindful that the 1^st Quarter will end on March 30^th for financial markets. Window dressing and portfolio painting are likely to occur next week. I would not be at all surprised to see the tape painted to the upside during the final week of March after this brief pullback that we witnessed on Thursday and Friday morning.

Money managers want to show off their returns while demonstrating ownership of key names that drove performance during the quarter such as AAPL. I expect the price action on Friday and the rest of next week to have relatively light volume and a bias to the upside.

Barring any major financial news or geopolitical event, I do not expect to see price action work below the 2011 highs in the near term. The possibility cannot be totally ruled out, but it would seemingly be a rare occurrence to see a major support level break down on the first back test attempt. We may see lower prices early next week, but if the 2011 highs hold the bulls remain in control in the short term.

The real question readers should ask themselves is if prices do extend higher and we reach my target resistance zone for the S&P 500, will the retail crowd jump in and push prices higher, or will the banks be trading with each other as a major top forms? In coming days and weeks we should find out once and for all just who the real muppets truly are.

Over the past 5 months subscribers of my options trading newsletter have won 19 out of 20 trades. That’s a 95% win rate,  pocketing 294% in gains focusing only on low risk credit spread options strategies.

If you are looking for a simple one trade per week trading style then be sure to join www.OptionsTradingSignals.com today with our 14 Day Trial

Jw Jones

We live in a world where headlines can move the market in split seconds as high-frequency trading robots cause flash rally’s and flash crashes regularly.

As an example, the price action in the Market Vectors Short Muni Index (SMB) on February 28^th demonstrates the impact that these high frequency traders have on illiquid underlying assets.

We certainly hope there were not any absent minded retail investors that got caught using market orders during the flash rally only to recognize losses as great as 5% or more in a matter of minutes.

The following chart illustrates a flash rally and the monster 40% plus rally witnessed in less than 1 minute. Can someone say fat-finger mistake?

Market Vectors Short Muni Index 1-Minute Chart

In addition to high-frequency trading, we have to constantly monitor the headlines coming out of Europe as one event or official statement has the potential to cause the Euro to rally or selloff almost instantly whether the information is fact or fiction.

We have traded small for the most part during the beginning of 2012 as market conditions have been volatile even if the volatility index (VIX) has not necessarily supported that view.

One after another, perma-bears have capitulated to the bullish camp and now we have pundits calling for the Dow Jones Industrial Average to move over 15,000 by the end of the year.

We both use strategies which in many cases would be considered contrarian by nature. Admittedly we will not get every move in the market correct, but what we will do is layout key areas that price action should migrate to in the form of key price levels across short, intermediate, and long term time frames.

Our objective is to provide readers and our members with actionable information which can be viewed objectively by both bulls and bears alike. With that said, the following viewpoint we have of the marketplace today runs contrary to the collective group of market pundits.

While most market pundits expect higher prices and stronger economic data, there is reason to believe that recent developments could be indicating that volatility may lurk ahead. Volatility could rise up and push equity valuations lower in the near term.

The daily chart of the Ipath S&P 500 VIX Short-Term Futures ETF (VXX) shown below illustrates that the VXX has seen strong volume in the past few weeks. Additionally the VXX appears to be trying to form a bottom.

With volatility at these levels, put protection is cheap and it would appear based on volume that the smart money is getting long volatility. Long VXX trades are designed to either act as a portfolio hedge or as a potential profit mechanism should a correction play out.

Ipath S&P 500 VIX Short-Term Futures (VXX) Daily Chart

By now most readers are aware of the rally that has been taking place in oil futures for the past few weeks. Nancy Pelosi came out with a statement blaming those evil speculators again while Republican Presidential hopefuls used higher oil prices as another key political topic against the current administration.

Just when the noise was starting to rise to a roar, the marketplace was quieted by a rally in the U.S. Dollar on February 29^th. The daily chart of the Dollar Index futures is shown below.

Dollar Index Futures Daily Chart

Do readers find it rather odd that just about the time when oil was on the lips of every media personality in the United States that the Federal Reserve issues a reverse-repo to pull in liquidity? Do you find it at all coincidental or could it be that Mr. Bernanke was told to slow down the rally in oil prices?

After the reverse-repo was performed, the Dollar soared higher and was showing continuation to the upside on Friday afternoon during intraday trade. The Dollar is potentially forming a bottom presently and the fact that the Federal Reserve is aiding in that formation presents additional risk for downside in the S&P 500 Index and precious metals in the near term.

For the past several weeks the U.S. Dollar Index has pulled back and the S&P 500 definitely took notice. However, the Dollar is on the verge of carving out a weekly swing low which could have legs to much higher prices.

While many pundits routinely mock the Dollar and trash it, in the event of a major currency or credit event in Europe the Dollar will be one of the key safe havens that large sums of wealth will migrate too.

If the Dollar Index Futures can push through the downtrend line illustrated on the chart above with strong supporting volume a much larger move higher will likely play out. Should that scenario play out, the S&P 500 Index will likely begin to rollover.

It should be noted that the S&P 500 has struggled on multiple occasions to break above the key 2011 highs. The S&P 500 Index daily chart below demonstrates the resistance directly above current price action.

S&P 500 Index Daily Chart

We have been bearish on the S&P 500 since price was testing the 1,330 price level. After the subsequent breakout we targeted the key 2011 highs as a last stand for the bears. If the Dollar finds a bottom and rallies sharply higher from current levels a correction in the S&P 500 will likely play out.

The other possibility would be a breakout over current resistance levels which would likely see the S&P 500 move to the 1,400 level if not higher in a matter of a few weeks. We are not leaning in either direction in terms of price action currently, but we are expecting the VIX to move higher in coming weeks and months ahead.

In our most recent collaborative missive, we discussed the fundamental case for gold prices going higher over the long term. Cleary the price action this week (specifically the price action on Wednesday February 29^th) has been bearish and we expect to see prices chop around with a potentially bearish view for the next few months.

Gold Futures Daily Chart

While gold has pulled back sharply, the likely move lower in coming weeks and months ahead will offer a strong buying opportunity for investors that are patient. If the Dollar breaks out to the upside which we anticipate, gold should move down into a significant low.

Should this scenario play out an entry point near the low will likely offer strong upside potential. In fact, it might be the last deep low before a prolonged period of choppy price action until the Dollar tops.

We firmly believe that as long as central banks continue to print money with wreckless abandon, the fundamental case for gold remains quite strong in the longer term.

We have received a lot of emails recently asking about our opinions on the future price action in oil. Even though the Dollar may breakout to the upside, oil has a risk premium built into the price already for potential geopolitical conflict. However, military action in the Middle East could easily push prices higher.

Should oil push higher and test the 2011 highs and breakout to the upside, the likely results will be a weakening in the domestic economy as gasoline and diesel prices would surge higher. A surge in oil prices has a direct implication to the domestic U.S. economy as the cost for nearly everything will rise. The daily chart of oil futures is shown below.

Oil Futures Daily Chart

Conclusion for what to expect next:

Ultimately we believe the two most critical assets to monitor at this time are the U.S. Dollar and oil futures. The U.S. domestic economy cannot handle significantly higher oil prices from the current levels without seeing business growth slow. Furthermore, if the Dollar rallies it could put pressure on the equity markets as well.

While the equity markets and the economy are not the same thing, it is important to note that higher oil prices at a certain point will become equity negative.

The VIX is sending a warning that market participants are too complacent and the Dollar is potentially forming a rounded out bottom. These two conditions paired with geopolitical risk in the Middle East represent additional risks to economic growth.

Furthermore, market participants cannot become complacent regarding the potential risk that Europe still poses. With the various risks listed above in mind, we are keeping position sizes small and are attempting to remain Delta neutral in our portfolios. Risk is beginning to elevate to extremes.

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

Chart Courtesy of the American Association of Individual Investors

Clearly investors are growing considerably more bullish at the present time.  The bullishness being exhibited by market participants is rather interesting considering the notable headwinds that exist in the European sovereign debt markets, the geopolitical risk seen in light sweet crude oil futures, and the potential for a recession to play out in Europe.

To further illustrate the complacency in the S&P 500, the daily chart of the Volatility Index is shown below:

The VIX has been falling for several weeks and is on the verge of making new lows this week. If prices work down into the 16 – 18 price range a low risk entry to get long volatility may present itself. For option traders, when the VIX is at present levels or lower there are potentially significant risks associated with increases in volatility.

My expectations have not changed considerably since my article was posted last week. However, I continue to believe that the bulls will push prices higher yet in what I believe could be the mother of all bull traps. Let me explain. As shown above, we have strong bullish sentiment among market participants paired with general complacency regarding risk assets.

As I pointed out last week, my expectation if for the S&P 500 to top somewhere between 1,292 and 1,325. A lot of capital is sitting on the sidelines presently and if prices continue to work higher I suspect that a move above the 1,292 price level will trigger a lot of long entries back into stocks or other risk assets.

We could see prices extend higher while the “smart” money sells into the rally. Retail investors and traders will point to the inverse head and shoulders pattern on the daily chart of the S&P 500 and the breakout above the key 1,292 price level. The pervasive fear of missing a strong move higher will help fuel long entries from retail investors.

At the same time retail investors begin buying, a lot of committed shorts will be stopped out if prices push significantly above the 1,292 area or higher toward the more the obvious 1,300 price level. Thus, there will be few shorts to help support prices should a failed breakout transpire. A perfect storm could essentially be born from the lack of shorts to hold prices higher paired with the trapping of late coming bulls.

The daily chart of the S&P 500 Index below illustrates what I expect to take place in the next few weeks:

I want to reiterate to readers that it is not totally out of the question that the 1,292 price level could hold as resistance or that we could roll over early this coming week. Additionally a breakout over 1,330 will certainly lead to a test of the 2011 highs around the 1,370 area.

If the S&P 500 pushes above the 1,370 area we could witness a strong bull market play out. Ask yourself this question, what reasons could produce such a rally and what are the probabilities of that outcome transpiring in the next few weeks?

Obviously earnings season is going to be upon us shortly and if earnings come in below expectations a potential sell off could intensify. Furthermore, economic data in Europe continues to weaken and slower growth appears to be manifesting within the core Eurozone countries like Germany and France. If most of Europe plunges into a recession, deficits will widen beyond economic forecasts and the strain in the sovereign debt market of the Eurozone will increase dramatically.

One key element that many analysts are not even discussing is the potential for higher oil prices to present additional economic headwinds for developed western economies.

Clearly the situation in the Middle East is unstable, specifically what we are seeing taking place in the Strait of Hormuz involving Iran. If a “black swan” event occurs such as a military conflict between the United States and Iran or Israel and Iran the prices of oil will surge.

In a recent research piece put out by SocGen, nearly every scenario that is referenced involves significantly higher oil prices. According to the report, the Eurozone is considering the banning of imported Iranian oil which could cause Brent crude oil prices to surge to a range of $120 – $150 / barrel according to SocGen.

The other scenario involves the complete shut down of the Strait of Hormuz by Iran. If this shutdown were to persist for several days the expectation at SocGen for Brent crude oil prices is in the $150 – $200 / barrel price range.

Clearly if either of these two scenarios play out in real time, the impact that higher oil prices will have on European and U.S. economies could be catastrophic.

The daily chart of light sweet crude oil futures is shown below:

I want readers to note that I am not suggesting that oil prices are going to rise or fall, just outlining the report from SocGen about where they expect oil prices to go should either of the two scenarios presented above play out. If oil prices were to work to the $125 / barrel level and remain there for a period of time, I would anticipate a very sharp decline in the S&P 500.

Currently there are a lot of headwinds for bulls, some of which could persist for quite some time. I intend to remain objective and focus on collecting time premium as a primary profit engine for my service at OptionsTradingSignals.com.

Once I see a confirmed move in either direction I will get involved. For now, I intend to let others do the heavy lifting until a low risk, high probability trade setup presents itself. Risk is increasingly high.

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

I do not envy Santa as he has the most arduous task of determining if Wall Street was naughty or nice. I suppose it depends on whether he reviews recent performance, or if past performance comes into play. Clearly coal will likely be found in a few stockings soon enough. If I were John Corzine, I would not expect to get a lump coal, but something far worse potentially.

In all seriousness, the bullishness has gotten pervasive in the media and economic data points such as unemployment and consumer credit have improved according to the government. One way to gauge investor sentiment is to look at the weekly advisor sentiment numbers courtesy of Bloomberg and Investor’s Intelligence.

According to this week’s advisor sentiment numbers, advisors who are bullish advanced to 47.4% from 44.2% last week. Bearish advisors dropped to 29.5% from 30.5% from the previous week. The 29.5% bearish data point matches a level that has not been seen in nearly 4 months. Bullishness has clearly become the leading expectation in the marketplace.

Only one asset has the opportunity to be “The Grinch” and ruin Christmas on Wall Street. If the U.S. Dollar rallies sharply, risk assets are certain to get hammered lower. In addition to the bullish tenor of market participants, most market pundits and gold bugs believe strongly that the U.S. Dollar is doomed fated for lower prices.

When I look at the long term momentum of a stock or commodity contract I will look at a monthly chart and plot the 12 month moving average against the price action. While it seems simple, equity and futures positions adhere to the 12 month moving average quite closely in many cases. The analysis is very simple as prices above the 12 month moving average equate to bullishness and prices below the moving average predict lower prices. The monthly chart of the Dollar Index futures is shown below:

As can be seen above, the Dollar Index futures are showing strength currently. The 12 month moving average is starting to flatten out which is also a bullish indicator. When looking at the daily time frame we can see that price action is trading inside a wedge pattern and is bouncing higher off of support:

An additional catalyst that could push the U.S. Dollar higher is the economic tragedy that is Europe. European political leaders need to come up with a series of strong solutions that will stabilize their economic crisis otherwise the Euro will weaken further. A weakening or potentially crashing Euro will push buyers back into the U.S. Dollar. This would in turn place downward pressure on equities and commodities.

S&P 500

On Thursday the S&P 500 flushed over 2% lower by the close as the European Central Bank disappointed investors with an expected 0.25% rate cut and no new bond purchase announcements. The bulls will tell you that the Thursday the week prior to monthly option expiration usually is volatile and price direction is generally in the opposite direction of the primary trend. We will find out next week whether that axiom holds true. The daily chart of the S&P 500 is shown below:

The strength of Thursday’s move is not going to easily be reversed. The European leaders need to shock the market with tangible decisions and launch a major offensive against their growing fiscal issues. If European leaders disappoint investors, the reaction to the news could be a violent selloff that leaves bulls flatfooted next week.

Those who are leaning long in size should consider that their trading capital is being leveraged on the hope that European leaders can come to a groundbreaking agreement. I will be in cash watching the price action in the S&P 500. However, once the dust settles and others have done the heavy lifting, I will likely get involved with a directional trade. Until then, I am just going to ponder if I were Santa, would Wall Street get a present or a lump of coal?

Get these weekly reports and trade ideas free here: www.Optionnacci.com

JW Jones

In addition to the risk posed by Europe, the market’s reaction to the Congressional Super Committee’s upcoming statements also poses risks. As it stands now, the media is reporting that the committee is in gridlock and has yet to compromise. The deadline for the Super Committee is Wednesday, November 23^rd. The gridlock leads to uncertainty, and Mr. Market hates uncertainty. High levels of uncertainty corresponds with increased volatility levels, thus caution is warranted.

Recently I have been actively trading around the wild price action, but I have been utilizing smaller position sizes in light of the elevated volatility levels. In addition to the smaller position sizes, I have been aggressively taking profits and moving stops in order to protect trading capital.

This past week, members of my service enjoyed two winning trades. We were able to lock in gains on a SPY Put Calendar Spread for a nice 20% gross gain. On Friday we closed a USO Put Calendar Spread for a gross gain of 17%. These trades were relatively short term in duration, but the gains they produced were strong.

Both trades took advantage of increased volatility which resulted in enhanced profits. If volatility remains elevated going forward which I expect, these types of trades will offer great risk / reward going forward. Volatility is an option traders friend, and this past week members of my service were able to lock in some strong gains with relatively muted levels of risk.

Gold Futures

I have not written much about gold recently as I have honestly not seen a great deal of opportunity in either direction there. The price action has been quite volatile, but this past week we saw gold futures sell off sharply. I believe the explanation for the selloff is partially due to strength in the U.S. Dollar. The daily chart of the U.S. Dollar Index is shown below:

The recent selloff in gold can likely be attached to the increase in margin calls around the world as a likely consequence of the MF Global bankruptcy. Uncertainty surrounds the commodities market as the collapse of MF Global has interrupted traditional capital flows and broad based volume around the world. The MF Global situation continues to provide a negative headwind for financial markets in general.

I continue to be a long term bull regarding precious metals as nearly every central bank is either printing money deliberately or is increasing the money supply through quantitative easing. With multiple calls coming out of Europe over the weekend for the European Central Bank to print money to monetize European sovereign debt, it may not be long before the ECB begins their own quantitative easing program. In the long term this can only mean higher prices for gold.

Right now the short term looks bearish for gold as the daily chart of gold futures shows gold tested near the top of a recent rising channel and failed. The selloff was strong, but  a pullback here makes sense from a technical perspective. The daily chart of gold is shown below:

The longer term time frame continues to remain technically positive for the yellow metal. As long as gold prices hold in their multi-year rising channel, higher prices remain likely. Right now the $1,500/ounce price level needs to hold as support if the bulls are going to remain in control in the long term time frame. The weekly chart of gold futures shown below illustrates the long term rising channel:

Right now we are in a seasonally strong period for gold. I am going to be watching closely in coming weeks for a solid entry point to get long the yellow metal for a longer term time frame. Right now the short term remains bearish, but the longer term is bullish from technical and fundamental viewpoints.

S&P 500

The S&P 500 Index sold off sharply during the past week. In my most recent article, I discussed two key price levels to monitor to the downside. The key support levels were the 1,230 and 1,190 price levels respectively. The bulls need the 1,190 area to hold as support to give them any chance for a “Santa Claus Rally” into year end.

Last week the S&P 500 Index closed below the 1,230 support level meaning the 1,190 area has to hold. Otherwise, we could see a sharp selloff into the end of the year. The daily chart of the S&P 500 below illustrates the key support levels:

The S&P 500 looks vulnerable to the downside presently. However, headlines coming out of Europe and/or the Super Committee this week could push prices higher. The key pivot line remains around the 1,257 price level on the daily chart. If the bulls can regain the 1,257 price level on a weekly close a test of 1,290 will become more likely. However, as long as prices remain below 1,230 and 1,257, the S&P 500 is vulnerable to additional downside.

I would not be shocked to see the S&P 500 push higher this week to work off short term oversold conditions. Truncated weeks result in lower than average volume which generally favors the bulls. However, in this environment anything could seemingly happen. Risk is high in either direction.

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

I generally will not make bold predictions as today’s financial markets are so dynamic that a lot can change in a short period of time. However, Tuesday night I sent out a video to members of my service which I entitled my “European Rant.” My soapbox rant discussed where we were in the market and what my thoughts were regarding the structural issues in Europe.

Watch my European Rant here: European Rant

Little did I know that the very next day Italian 10 year bond yields would surge calling the fiscal stability of the Eurozone back into question. My intent for the video was to give my members a better understanding of what was going on in Europe. As it turned out, the video was spot on in its timing so I could not help but share it with readers.

My current view on the S&P 500 is neutral. I am watching several key price levels on the S&P 500 Index for clarity, but so far Mr. Market has not tipped his hand. I am watching for a breakout over recent highs around the 1,290 area before I consider layering back into long positions. Consequently, I am watching the 1,230 and 1,190 areas as potential short entry points. The daily chart of the S&P 500 Index is shown below:

Clearly the 1,190 – 1,200 level should offer strong support as the 50 period moving average is resting right at the 1,200 price level currently. If the 1,190 price level breaks down I think we could see a dramatic selloff transpire. On the flip side, if the recent highs around 1,290 are taken out to the upside we could see a rally that takes us back to the 2011 highs around 1,370. Right now I am going to wait patiently and let others do the heavy lifting.

The 1,257 price level on the S&P 500 Index is a major pivot that I am going to be watching closely. If the bulls can push prices above that area for two or more consecutive closes I think the bulls may have the bears on the ropes. As of the writing of this article, the SPX is currently trading around the 1,263 level. If the bulls can hold up prices into the closing bell, we could see an extension higher on Monday. The chart of SPX below illustrates the key 1,257 price level:

At the close on Tuesday I was involved in a SPY 122 Put Calendar Spread for members which capitalized on time decay (Theta) as well as lower prices in the SPY ETF. Thursday morning I took profits on the position locking in a gain of around 13% on maximum risk. Recently I have had several winning trades for members of my service, but I admittedly have been taking profits aggressively and trading in smaller size due to the wild volatility swings that are commonplace in this market.

Trading is a marathon, not a sprint and my focus is to live to play another day. Since the inception of my service, I am running at about a 70% success rate based on all trades that have been taken. I am not telling you this to boast, I am telling you this to point out that I am wrong 30% of the time. In the trading world the overall numbers look good, but if my position sizing is not appropriate the 30% could potentially blow up my account.

With that in the back of my crowded mind, I try to use smaller position sizes and lock in profits aggressively during times of widespread volatility. I take fewer trades and focus my attention on risk and money management during times of heightened volatility which has been prevalent the past few weeks.

In addition to monitoring my risk profile, I am watching the price action in two underlying assets which I believe will throw off clues about where this market may be headed. The EUR/USD currency pair has been on my screens quite a bit the past few weeks. Most of the time I monitor the U.S. Dollar Index futures as well, but recently my focus has been on the currency pair. The chart below illustrates the correlation between the Euro currency and the S&P 500 since September:

Since the beginning of September, the moves in the S&P 500 have been very similarly correlated to the Euro currency as can be seen above. Additionally the Dow Jones Industrial Average also has very similar congruence in terms of price action when compared to the Euro.

The strength of the Euro has a profound impact on the price action of the U.S. Dollar Index. The U.S. Dollar Index soared on Wednesday and took out recent resistance. Since Wednesday, the Dollar has been retracing a large portion of the move higher. The daily chart of the Dollar Index is shown below:

It is a bit too early to tell for sure, but the Dollar could be rolling over based on austerity plans coming out of Italy and the expectation that the Eurozone is going to try to get ahead of the crisis unfolding based on the yields of Italian government debt instruments.

Last and certainly not least is the banking sector of the economy. The KBW Banking Index (BKX) is a proxy for financial institutions domestically. The KBW Banking Index is a great indicator for the future price action in the S&P 500. Stocks cannot rally if the banks do not participate with higher prices.

If stocks are selling off and the financials are holding up well many times equity indices will reverse higher. The key price level that a lot of traders are monitoring currently is the 40 area. The daily chart of the KBW Banking Index is shown below:

Similar to the key 1,257 pivot level on the S&P 500 Index, the key 40 price level on the KBW Banking Index has a similar impact on the underlying price action. If the bulls can push the BKX above the 40 price level and hold it up then a rally in stocks becomes more likely. As I write this, the BKX is trading at $39.78 / share so we are getting close to crunch time. The S&P 500 has broken above its pivot during intraday trade and now a lot of eyes are watching to see if the banks can follow through.

Ultimately investors could be looking at a Santa Claus rally or an absolutely ugly selloff in the near future. I will be monitoring the key price levels mentioned above on the S&P 500 and will wait patiently for Mr. Market to tip his hand. This is a tough market to trade and volatility is running relatively high. Headline risk coming out of Europe is seemingly constant. I would keep position sizes light and monitor risk aggressively. This is not the time to be a hero!

Subscribers of OTS have pocketed some serious return in the past few months. If you’d like to stay ahead of the market using My Low Risk Option Strategies and Trades check out OTS at www.OptionsTradingSignals.com and take advantage of my professional trading alerts and position management experience each week.

JW Jones

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

Some market pundits would argue that gold and silver would likely benefit and I would not necessarily argue with that logic. However, the physical gold and silver markets are not that large and depending on the breadth of the situation, vast sums of money would be looking for a home. The two most logical places for hot money to target in search of safety would be the U.S. Dollar and U.S. Treasury’s.

The U.S. Dollar and U.S. Treasury obligations are both large, liquid markets that could facilitate the kind of demand that would be fostered by an economic event taking place in the Eurozone. My contention is that the U.S. Dollar would rally sharply along with U.S. Treasury’s and risk assets would likely selloff as the flight to safety would be in full swing.

To illustrate the point that the U.S. Dollar will likely rally on a European crisis, the chart below illustrates the price performance of the Euro compared to the U.S. Dollar Index. The chart speaks for itself:

Clearly the chart above supports my thesis that if the Euro begins to falter, the U.S. Dollar Index will rally sharply. In the long run I am not bullish on the U.S. Dollar, however in the case of a major event coming out of the Eurozone the Dollar will be one of the prettiest assets, among the ugly fiat currencies.

The first leg of the rally in the U.S. Dollar occurred back in late August. I alerted members and we took a call ratio spread on UUP that produced an 81% return based on risk. I am starting to see a similar type of situation setting up that could be an early indication that the U.S. Dollar is setting up to rally sharply higher in the weeks ahead. The daily chart of the U.S. Dollar Index is shown below:

As can be seen from the chart above, the U.S. Dollar Index has tested the key support level where the rally that began in late August transpired. When an underlying asset has a huge breakout it is quite common to see price come back and test the key breakout level in following weeks or months. We are seeing that situation play out during intraday trade on Friday.

We are coming into one of the most important weeks of the year. Several cycle analysts are mentioning the importance of the October 26^th – 28^th time frame as a possible turning point. I am not a cycle expert, but what I do know is that we should know more about Europe’s situation during that time frame. It would not shock me to see the U.S. Dollar come under pressure and risk assets rally into the October 26th – 28^th time frame. However, as long as the U.S. Dollar Index can hold above the key breakout area the bulls will not be in complete control.

If I am right about the U.S. Dollar rallying higher, the impact the rally would have on gold and silver could be extreme. While I think gold would show relative strength during that type of economic scenario, I think both metals would be under pressure if the U.S. Dollar started to surge. In fact, if the Dollar really took off to the upside I think both gold and silver could potentially selloff sharply.

As I am keenly aware, anytime I write something negative about gold and silver my inbox fills up with hate mail. However, if my expectations play out there will be some short term pain in the metals, but the selloff may offer the last buying opportunity before gold goes into its final parabolic stage of this bull market. The weekly chart of gold below illustrates the key support levels that may get tested should the Dollar rally.

For quite some time silver has been showing relative weakness to gold. It is important to consider that should the U.S. Dollar rally, silver will likely underperform gold considerably. The weekly chart of silver is illustrated below with key support areas that may get tested should the Dollar rally:

Clearly there is a significant amount of uncertainty surrounding the future of the Eurozone and the Euro currency. While I do not know for sure when the situation in Europe will come to a head, I think the U.S. Dollar will be a great proxy for traders and investors to monitor regarding the ongoing European debacle.

If the Dollar breaks down below the key support level discussed above, gold and silver will likely start the next leg of the precious metals bull market. However, as long as the U.S. Dollar can hold that key level it is quite possible for gold and silver to probe below recent lows.

Both gold and silver have been rallying for quite some time, but the recent pullback is the most severe drawdown so far. It should not be that difficult to surmise that gold and silver may have more downside ahead of them as a function of working off the long term overbought conditions which occurred during the recent precious metals bull market.

Make no mistake, if the Dollar does rally in coming months risk assets will be under significant selling pressure. While the price action will be painful, those prepared and flush with cash will have an amazing buying opportunity in gold, silver, and the mining complex. Right now, risk remains excruciatingly high as the European bureaucrats wag the market’s dog.

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JW Jones

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.