I mentioned I would touch on the idea of “Pillars of the Market” on Sunday Scan, so that’s what this post will mostly be about.

The concept is this:

An index like SPX/SPY (but this also applies to QQQ, IWM etc.) is impacted by many individual parts. Each index has its own set of holdings that have a significant effect on the index as a whole. SPX/SPY is made up of 11 sectors, and a variety of individual stocks make up those sectors. QQQ is mostly tech focused and IWM is mostly small cap focused.

The goal is to be able to identify the most important things that impact an index so that we can see when there may be a change or a move approaching.

The S&P 500 is a market cap weighted index, meaning that the larger the market cap of a stock, the bigger its place is in the SPX/SPY index. These are the top 12 holdings of SPX/SPY as of March 2024.

The top 6 holdings, which are all big tech names, currently make up about 26% of the index, and the top 12 names make up about 35% of the index. The concentration in the largest names is useful to us because if we start to see a trend change in these handful of names we know that it can really move the needle for SPX/SPY. This is what I would call a pillar of the market – a small group of large tech names – something that has a disproportionate impact on the market index.

This brings me to the next pillar, XLF. This is about a 13% weighting of SPX/SPY and is made up of the largest financial companies in the market. While it may not be quite as impactful as large tech, it is still a significant driver of the S&P 500 on any given day. A good rule of thumb is that when XLF is up or down around 1% or more, it has high correlation with the direction of SPX/SPY for that day. So, if XLF is really strong, I’m usually not looking for downside in SPX, and if XLF is really weak, I’m usually not looking for upside in SPX unless XLF starts to reverse trend. Financial institutions are reactive to interest rates, market risk, and macro news which makes them uniquely useful as a market pillar.

This brings me to the next pillar which is the option market in SPX/SPY. You may not be an options trader, but this will still be useful for you. To put it simply, options have a large impact on SPX/SPY. The amount of contracts traded, and the buying or selling of the S&P 500 futures contracts used to hedge these positions, can move SPX/SPY up, down, or keep it “pinned”(stuck) in place. This has become more prevalent over the last few years with the rise of 0DTE (zero days to expiration) options.

The lighter blue portion at the bottom of these graphics shows the growth of 0DTE options over the last few years. It’s currently estimated that roughly half of all SPX/SPY options come alive and die in the same day now. This means that when there is large influx of call positioning or put positioning, the market tends to follow these moves. It also means that when reversals happen, (people unload calls or puts) that the impacts can be sharp. By understanding some basic options ideas and knowing who to ask for help to get a read on things, you can have a good idea of where the market may be headed or stuck at on a given day. This is another pillar.

Next we have the VIX. In simple terms, this measures the likelihood of near-term market volatility, especially when that volatility may be a market drop. For our purposes, when the VIX rises, people are usually hedging for downside volatility ahead. And conversely, usually when the VIX is heading lower, people are usually not expecting downside, and the market may drift higher, especially after important market-moving events. This is another pillar that can be used to see how the market is likely to act on a given day.

There are complex things that go into the calculation and dynamics of the VIX, but don’t get too caught up and miss the big idea while focusing on the smaller details.

Lastly, sharp moves in the US Dollar and interest rates/bond yields can also impact SPX/SPY. It’s important to remember that the stock market isn’t the biggest market out there. The bond market is massive and fast changes in interest rates or bond yields can be very disruptive (think of Silicon Valley Bank that went under from bond yield impacts).

MOST of the time, when bond yields rise quickly it can put downward pressure on both the bond market and the stock market. And again, MOST of the time when bond yields quickly fall the market gets a lift up.

However, during fearful market panics, like during the Covid crash, people tend to sell equities and buy bonds (because bonds have a fixed return), so you can have situations where bond yields fall very fast while stocks also fall.

Remember, the idea is to be familiar with these concepts, even if you don’t directly use them in your personal trading activities (yet).

SO, why do all of these pillars matter? Because each of them can directly impact how SPX/SPY moves on a day to day basis. Sometimes some of these pillars matter more than others. It all depends on what kind of market environment we are in. But in general, if all of these market pillars are bullish then there is an extremely likely chance that the market will be bullish. And if these pillars start to get bearish then the market is very likely to get bearish.

We can use these pillars to help us get clues of whether the market may trend in one direction, or if a reversal is coming if multiple pillars start to change from bullish to bearish or from bearish to bullish. There are lots of ways to craft trades in SPX/SPY from this information, or maybe you don’t trade SPX/SPY at all but can use these to help you trade your normal strategy a little bit better.

And it also goes without saying that there are lots of other factors that can move markets. These are just some of the most important “pillars” that I look at to help with my own trading.

I hope this information is useful to you and your trading.