The V Bottom PlayBook
- Posted by Frank Zorrilla
- on January 10th, 2015
The V bottom has become a phenomenon, one that has frustrated a lot of traders and probably a well known financial publication. It started mid 2012 and by my count it has happened 8 times and we are working on the ninth. Very simply, the V bottom is one where the market pulls back in a straight line down, freaks out investors/traders and gives them the feeling that this is the big correction that we’ve all been waiting for, and then it miraculously snaps back in a straight line up to a new high like if nothing ever happened. There has been no in between, it has been straight down follow by straight up action. It has frustrated many because the minute that they do the prudent thing which is protect capital, take their stop losses etc….this is exactly when the market snaps back with like 17 straight days of relentless buying that does not allow them back in without the feeling that they are chasing a runaway train.
Like everything else, this will end at some point, probably at the time when everyone gets comfortable with it. What we want to do is simply dance until the music stops, but at the same time look for signs for when the character of the V bottom might be changing. Here are some of the things that we know about the V bottom; (feel free to add in the comment section what you have noticed).
Here’s what we know;
- The average decline has been 6.48%, this is not a huge decline especially when the average intra-year decline in the last 34 years has been 14% (not in the last 2 obviously).
- The average decline has lasted 18 days however the pullbacks are happening a lot quicker recently, the average since 2014 is only 10 days.
- The average $VIX spike has been 74.74% (average within the date range), since 2013 the key number on the $VIX has been $12, a good level to buy some protection.
- The average spike on the $VIX (74%) seems a little to extreme for the size of the pullback we are getting.
- The round trip average to new highs has been 39 days but only 23 days since 2014. As a matter of fact, in the September 2014 pullback it was the first time in history that we went from an all time high in the SP500 to a 6 month low, back to an all time high all within 40 days.
- The average days from the lows to a new high has been 19 days but only 12 days since 2014. We are basically getting a years worth of SP500 gains in 2 weeks immediately after losing 1/2 of the 30 year average intra-year decline (14%) inside of 30 trading days.
- We have had 3 V bottoms in the last 3 months, this can be considered a character change.
- The NAAIM shows me that like many, the advisors being polled are being reactionary, out at the bottom, rush to get back in on the rebound.
Character changes I’m looking for;
- Every V bottom has reached a new high, look out for when it doesn’t reach a new high. So far the $QQQ failed to reach a new high after last months pullback and the jury is still out on the V bottom that is under way.
- Another possible character change would be a pullback in the SP500 that does not come with a huge $VIX spike (half the average would be a change, acceptance).
- A pullback in which the NAAIM index barely pulls back (acceptance).
- Frequency, if starts to happen a lot more within a short time frame. (we’ve had 2 in the last month, change)
- I would not put much weight on the sentiment on twitter due to the fact that what people do and say are two different things, even though some have been terrific contrarian indicators.
If we continue to see this playbook play out like it has, with the overreaction in the $VIX every time we get 5% pullback then I believe you should play the V bottom until we see the character changes. You can be right 99 times playing the V bottom and be wrong once, or you can be right 1 time fading the V bottom and wrong 99 times. The hard part is not putting money in the market when we are tanking, putting significant money behind it is the tough part.
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Frank Zorrilla is the founder and chief investment officer of Zor Capital LLC.He began his Wall Street career 10 days after his 20th birthday when he became a Series 7 licensed stock broker. More »
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