The Rotation Dance Is Cracking

My order hit the bid and didn't fill.

That doesn't happen to me. Maybe five times in my trading career has a market-limit order failed to fill the way that one did during this morning's session. The bid moved 50 cents in the time it took the routing engine to do its job.

When that happens, you're not looking at a quiet market with mild sell side. 

You're looking at a market where the desks on the other side are choking. 

They can't hedge fast enough, so their servers are throwing everything at the hedges because the positions themselves are getting thrown around so wildly they have to re-hedge every couple of seconds.

Price tells you nothing in those moments. Watch the fill quality instead.

So here's the setup from this morning's tape.

The S&Ps opened down half a percent. On a 7,000-point index, that's not even remotely interesting.

Volatility sat at an 18 VIX and the advance-decline line was a 50/50 slop fest. Nothing on the surface said wake up.

But the contract size in the S&Ps was running 7,000 to 8,000 contracts a minute, consecutive minutes, with a couple touching 10,000. That's almost as heavy as it ever gets, and that's not normal background trade. That was the rotation dance starting to crack.

For weeks the game has been the same. Sell side hits big tech and capital rotates into the XLF. Big tech rallies and capital rotates back out of financials.

Capital moves from one side of the boat to the other and back again. The whole thing works until it doesn't, and we're right on the cusp of the it-doesn't.

Here's why the financials matter so much.

The XLF hasn't barfed up yet. While the rotation dance keeps going, capital has a place to land every time tech sells off.

The moment the XLF cracks with tech is the moment the dance ends. That's when the dispersion trade starts to implode on itself. That's when volatility stops being an 18 VIX and starts being something the desks have to chase.

Watch the XLF this week. 

If financials sell off while tech sells off, the S&Ps are down 80 to 90 handles in a hurry, not because the index found a new low but because the rotation game ran out of chairs.

Then there are the bonds.

The 10-year went from 4.3 to 4.6 in a week. That's not climbing. That's exploding higher.

Kevin Warsh got sworn in Friday. Shortly after his swearing in, he might have to raise rates whether he wants to or not. Rates raise themselves when the bond market gets there before the Fed does.

At 4.7, people start getting nervous. At 5, the Fed has to come out and do something, and I have no idea what that something is.

The play from here is straightforward.

Stop looking for news. The marketplace has priced peace in 40-something times already and we still haven't had peace.

Options order flow sets the path, not headlines. Whatever the news is when the bell rings, the bell rings on whatever the order flow built overnight.

Three things to watch this week: contract size in the S&Ps, a real break in the XLF, and the 10-year at 4.7. Anything else is noise.

The dispersion trade has been the easiest money in the marketplace for months. When it breaks, it doesn't unwind gradually. It snaps all at once.

If you've been riding the rotation, it's time to put your big boy pants on. The other side of this is loud.

If you want to know how to play it, you can follow me in the TheoTrade Chatroom. 

To your success,

Don Kaufman