SP500 - What the Strong Hands are doing

The plot above illustrates the SP500 daily data over the past two years with the Vol State Space indicator overlay. This indicator attempts to clarify the accumulation vs. distribution process via the evolution of volatility under the assumption that there is a finite amount of volatility. I believe this is a unique and true assumption and can lead to very useful conclusions that allow one to see the big picture one step ahead of the crowd. I have been trading and studying for volatility for nearly 20 years across all asset classes and this simple but effective approach took a long time to "come to me". Of course its not infallible but I do think it is a logical approach and ties in very well with other "correct" approaches such as wider vs. narrow bases in point & figure charting which indicate the pent up energy developed. (if you are unfamiliar with point & figure charting, I suggest you learn asap!).

So how does this indicator work? In a nutshell, the red line identifies dynamic price points where accumulation or distribution is ready to take place. This is where the strong hands get involved. So beginning with the far left of the chart, you can see that the price action is consistently above the red line which indicates the market is bullish biased. I have circled the interesting points along this chart. The first green circle on the far left took place Feb 2010 where prices dropped but found strong support at the red line where strong hands began accumulating. The next green circle I have drawn took place early May 2010 at the bottom of the flash crash where once again prices met the red line and found support. But the 3rd green circle I have drawn is found late May 2010 and identifies the red line separating from the upper blue line. This suggests the market bias is changing from bullish to neutral or bearish. Going forward from this point we see prices are below the red line

which should be viewed as bearish (or neutral depending upon whether the red line below prices still exists). The 4th green circle is drawn at the Aug 2010 top which took place at the red line - the price point where strong hands got involved again. Finally at the end of Aug 2010, the upper red line once again merged with the upper blue line while the lower red line separated from the lower blue line. Now we see once again there is just one red line and prices are above it suggesting a bullish bias has resumed. And that is how the process works. Prices move consuming a fixed amount of volatility - a type of state space analysis (hence the name Volatility State Space).

So what is it telling us now? I have drawn 6 green circles at specific price poings since June 2011. Each of these points highlights prices where either accumulation or distribution has taken place OR where the price action has become bearish bias or bullish bias via the red line separating from the outer blue line. The 2nd green circle from the right identifies the upper red line merging with the upper blue line. This point ended the bearish bias and indeed prices shot higher out of the volatile wide range that took place during August - September 2011. The far right green circle highlights the lower red line separating from the lower blue line and this now says the market is bullish biased as of early November. This lower red line is rising fast due to the high volatilities and will "push" prices higher. Hence it is now logical to trade WITH the strong hands and trade primarily from the long side. The bears will be watching for the upper red line (does not exist right now) to separate from the upper blue line to reinstate a neutral or bearish bias. Short term SP500 target is 1325.