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Friday, June 7, 2002 5:58 PM EST
All daily charts have been updated. Check back this Sunday for the regular weekly commentary.
Thursday, June 6, 2002 10:13 PM EST
A subscriber emailed me after the close today with an excellent point. She said that I am fighting the tape and that I should wait for a turn before trying to pick a top or bottom, as oversold can become more oversold and overbought more overbought. She is exactly right - couldn't be more so. However, that is not the point of this service. As I state several times on the site and on every email, these model signals are not trading signals in any way, shape or form. If you use them to trade, you will lose money in the long run. Period, end of story. So then what's the point of sending out a signal? Well, it's to alert you that sentiment has become extreme and begun to reverse in whatever time frame the model is meant to reflect. I am not going to wait until the trend changes before I send out a signal for one reason and one reason only...when does the trend change? Is it when it crosses the 50-period moving average? Is it when it breaks an uptrend line? Is it when it pierces yesterday's high? Is it when it makes a higher high and a higher low? Any and all of the above are valid, so which one do I pick? I don't, because each and every one of you would most assuredly give a different answer. I do not give trading advice, pure and simple. If I wait for a trend change, then I would be forcing my methodology onto you, since I would be determining when a trend changes. That's also why I simply wait for a reversal of a model extreme when sending out the signals. I could optimize the models so that I only send out signals when it has the greatest chance of not reversing back and becoming more extreme, but that would defeat the purpose of the emails - to keep you informed. I don't want anyone to trade on these signals, but I do want you to know what's going on. My intention is NEVER to pick tops or bottoms, but to give you objective evidence of what has happened in the past when we have whatever conditions we have that day. I try really hard not to predict, but sometimes (oftentimes?) I fail and end up giving you my opinion of what I think will happen. Please always keep in mind that I am simply weighing the odds of one event over another based on precedent. If I'm wrong, so be it. If I'm right, so be it. I don't have any influence over the market, and the odds are what they are.
I also happen to believe that price action is what matters most. Just because I send out a BUY signal, that does NOT mean I have taken a long position. I will most likely be looking to go long, but not until the trend, as defined by my methodology, changes.
Today obviously was a dismal day, but it does not change the odds of an intermediate-term rally at all - in fact, it makes them stronger from this point, and increases the chances that the rally could have more legs than just on an intermediate term.
As of today, virtually every one of our daily and intraday indicators is at an oversold extreme:
Add to that the fact that the sentiment surveys are bullish and the NYSE Members report is bullish.
The only bearish indicator that I track is the Commitments of Traders report. I'm not going to try to make excuses as to why it won't be accurate this time - it's just plain bearish and that's all there is to it.
One of the indicators I like to track but haven't posted to the site yet is the spread between the 10-day OEX put/call ratio and the 10-day total put/call ratio on the CBOE. For anyone interested in another look at the data, Carl Swenlin has an article in the most recent (June 2002) issue of Active Trader magazine. The basic theory behind this spread is that the bigger players (we're going to assume this is the smart money) use OEX index options while the small players (supposedly the dumb money) use options on individual equities. When these two put/call ratios strongly diverge, it gives a hint as to the way these two groups are betting. Having traded index options extensively myself, and knowing that I can't be considered a "big" player, there is some overlap between these two groups. However, when there are divergent extremes, it often gives a good hint as to market direction. When the spread is large, then that means that the OEX put/call ratio is high (a lot of puts are being bought in relation to calls - the "smart money" is betting that the market goes down) while the total put/call ratio is low (many calls are being bought in relation to puts - the "dumb" money is betting that the market goes higher), and that typically spells trouble for the market. When the spread is low, then the opposite is usually true. The current spread is .15, which places it in the bottom 1.5% of all readings over the past 7 years. Going back to 1995, this low of a spread or lower has resulted in an average return about four times that of a random return over every time period up to 30 days, with an average "win" rate of at least 65% over every time period. The average winner was also larger than the average loser over every time period. You can see the results of the study in the Research section, along with a chart of the spread since 2000.
I mentioned a few days ago that we had a low volume ratio on the NYSE (it was 12%). We had another one today, at 16%. I went over the past 36 years to check past occurrences of two such low volume ratio days within two weeks of each other. The results were very similar to the last few studies I've posted - the average return was approximately triple an average return over every time period up to 90 days, with at least 65% winners. Past 15 days, it was at least 80% winners. The average gain was about twice the average loss.
As I write this, Intel came out with bad news after the close and the S&P futures are down another 12 points after regular market hours while the Nasdaq futures are down 35. This is much further than the odds suggested we would go without more of a rally than we had. If you think of sentiment as a rubber band (which I happen to think is a good analogy), then we are stretched almost to the breaking point. We currently have the greatest confluence of negativity since the last two major bottoms in April and September of last year. When we get to such an extreme, surprises tend to happen on the upside, sparking a series of so-called relief rallies. Whatever happens tomorrow, the odds are suggesting an intermediate-term upside move more than at any time in the last 9 months. Sure, we could continue lower, but it would be, in statistical terms, an "outlier". I've posted enough studies and thrown up enough charts in the past few days that I think it's bordering on overkill at this point. From a sentiment perspective, we are deeply oversold - oversold enough to compare our current situation with past major bottoms. Probability suggests very strongly that we will have a tradable intermediate-term (at least) rally beginning within the next few days. From which price point that will be, I don't know. I do know that I'm looking to go long for more than a trade.
Wednesday, June 5, 2002 11:37 PM EST
A rather positive day for the markets overall, as it salvaged a rather negative reaction to positive economic news. We didn't have a whole lot going on sentiment-wise, as we stay in the same mode we have been for the past couple of days, although the very short-term picture is not quite as bullish as it was earlier this week.
The STEM.MR model came close to SELL territory early this morning, but didn't quite make it there, as the VIX remained quite high and didn't allow low TRIN and put/call readings to trigger a signal. It closed the day in neutral territory.
Once again, the STEM model got frustrated right at the point where it could have issued a signal. One more day of selling would have more than likely gotten a BUY out of this model too, but it was not to be. We are still on the bullish end of neutral here.
The Composite model lost 6 points today, as it reversed from a high of 72 to today's 66. This is one of the reasons I stress that the odds of an intermediate-term rally are much greater than those of a severe decline. Pessimism has reached an extreme seen only a few times each year, and that almost always coincides with at least an intermediate-term bottom. I don't know if this is THE bottom. There are some pieces missing now that I would prefer to see to be more confident of a longer-term rally. The COT situation is one, and there are some other, less relevant sentiment conditions that are also not as oversold as they have been during past long-term bottoms. My philosophy is to take one day at a time and reassess our situation continually. At some point, sentiment will become overly optimistic and at that time the odds will favor the downside instead of the upside. I don't know how far that move down will take us, and anyone who tells you they do know is either lying or trying to sell you something.
A couple of the more popular sentiment surveys came out with figures showing more tempered optimism than has been the case. It's very possible we could get a BUY signal out of the AIM model next week with these new figures. The II % bulls decreased to 48.9 while the % bears increased to 31.3. The Consensus bullish % also dropped a couple of points. I continue to think the surveys are bullish, and this week's numbers have done nothing to change that except to make the bullish case stronger.
The VIX made the reversal I was talking about yesterday, and I'm quite sure that is setting off all sorts of buy alarms for those traders who use the VIX as a primary trading indicator.
There's not much to go over tonight, as we have seen an extreme and now must wait to see how it plays out. The odds say that it is much more likely that we will be modestly higher than today within 30 days or so than it is that we will go significantly lower. I don't know about the day-to-day fluctuations - we have to take that one day at a time. But over the coming weeks, it is likely we will work higher.
Tuesday, June 4, 2002 11:33 PM EST
It felt good to actually have a three star-rated signal in the STEM.MR model today, as it's been about three months since the stars have lined up this way (no pun intended, really!). When we get an extremely oversold short-term condition coupled with oversold intermediate-term conditions, it can spark some good moves. More than the quantity of the move, though, I look at the risk. Unlike many people you hear, I thought the lower-risk trade today was going long, not going short. Yes, we are in a defined downtrend and the technical damage is great. Yes, the news headlines are terrible. Yes, you would be going against good advice to stay with the trend. But sentiment can have a profound impact on price, when it becomes extreme. And it was extreme.
Enough about today - you're probably sick of hearing market recaps so I won't bore you with another. We closed today with the STEM.MR model once again in oversold territory, with a reading in the mid-80's. In my opinion, the most significant component of that model is the VIX. You can see from the chart (in the "Indicators - MR Components" section of the site) that we are in the 95th percentile of all readings over the past couple of years. I'm sure you keep hearing that the VIX isn't high enough, as it's only 27 or so. Bunk. The S&P rallied 250% from 1991-1997 while the VIX barely ever poked it's head over 25. Don't buy the garbage that this indicator doesn't work anymore - those people have no memory or data bank. If you use it properly, it can be a very potent indicator. My preference happens to be measurements away from the 10-day moving average. If you use some type of relative measure such as that, it should help you greatly. If you subscribe to the "under 20=sell and over 30=buy" crowd, you will be doing yourself and your brokerage account a disservice. Anyway, at one point today we were over 20% above the 10-day moving average, which happens only a few times each year and is normally a screaming buy signal. I say "normally" because you have to wait for the reversal (which actually may have already happened intraday today). It's possible the VIX could shoot higher in the coming days with another pronounced selloff, but it's unlikely.
The 10-day moving average of the TRIN is now quite close to 1.50. I don't place a whole lot of weight on this in a mechanical sense (e.g. 1.50 = buy), but it is still a very significant level that tells me we are oversold. Along with the advance/decline derivations, I use the TRIN to give me a general sense of how overbought or oversold we are. And we are oversold. Very.
Speaking of the advance/decline ratio, we are now significantly oversold at .45. You can see from the chart in the "Indicators - Breadth" section of the site that this level has corresponded quite well to past short- to intermediate-term bottoms in the past year. Not perfectly, but no indicator is. Just as significantly, we are at .46 on the NH/NL ratio. This has gotten much more extreme in the past, but we are nonetheless oversold here as well.
The Nasdaq daily cumulative TICK indicator is also oversold, reaching close to -2000 yesterday. The NYSE isn't as extreme, in fact it's just on the lower end of neutral.
The 10-day moving average of the CBOE put/call ratio continues to climb, hitting .85 today. I've already stated that this is bullish, and it continues to be so, along with the open interest ratio. No changes there.
Volume was the heaviest we have seen in a month. Down volume decreased a little from yesterday and up volume tripled on the NYSE, which is a positive sign.
Overall, nothing occurred today that changed my intermediate-term bullish posture. By bullish, that does not mean I am "predicting" a rally. It simply means that I believe very strongly that the ODDS now favor the upside more than the downside over the next few weeks. And I say "the next few weeks" due to historical precedence. If we rally strongly over the next few days and sentiment becomes too bullish, I could just as easily say the odds now favor the downside. I don't want to get locked into some stupid prediction when that is not my intention at all. If I ever say "the S&P will rise by 35 points by next Friday" or some such nonsense, someone please slap me.
Monday, June 3, 2002 9:03 PM EST
Don't panic.
I mentioned in the weekly commentary that I could see us testing the recent lows or slightly undercutting them, which we did in one fell swoop today. I believe very strongly that there is not much downside risk left without at least a moderate intermediate-term rally taking place beforehand. I continue to throw around the figure of a 5-8% rally, which is simply an educated guess on my part. I have no idea what the market will do (and neither does anyone else unless they know what every single market participant or would-be participant is thinking), but based on history and probability, a gain in that vicinity would be "typical". Of course, we could continue significantly lower, but that would defy almost overwhelmingly small odds.
The Composite model today is giving a reading of 72%. I issued a BUY signal for this model this morning, since we got a reading of 66% on Thursday and 63% on Friday, which constituted a unique occurrence. I had no idea the model would turn around and continue higher, of course. Looking over the past couple of years, market performance after a reading of 72% or higher is astoundingly bullish, particularly after two weeks' time. After 30 days, the market was higher every time, for an average gain of over 8%.
Down volume swamped up volume on the NYSE today. The volume ratio (up volume / (up volume + down volume)) was 12%. I suggest you take a look at the study posted to the site under the "Research" section. I looked at data going back to 1966, checking for occurrences when the volume ratio was this low. Over the past 40 years, we have seen a reading this low only 180 times, which puts today's reading in the bottom 2% - quite significant. Moreover, instead of being bearish for the market, this type of reading was exceedingly bullish, as it may signify a selling climax. The study posted to the web considers the past five years, and as you can see from the table, market performance after these days was quite impressive. The average return after 30 days was around 5%, with a "win" rate of over 80%. A look at the chart posted under the study should give you a clue that doing some panic selling after these types of days was generally a huge mistake.
We got a divergence on the number of new lows on the NYSE today. Since February, while the market has made lower lows, so has the number of new lows (click on the chart below for a larger chart):
This may be a sign that the market is more healthy than many are giving it credit for.
An interesting development is the new bullish ratio on the www.lowrisk.com sentiment survey. At 27%, it is near the same level it was in early May and early February. The number of bulls dropped 21%, which is one of the largest one-week drops in the history of the survey. The web-savvy crowd is no more optimistic than anyone else it appears.
The 10-day moving average of the CBOE put/call ratio is back at .83, and the study posted in the "Research" section, referenced a couple of days ago, sheds some light on what kind of performance followed such a reading in the past. Another check in the bullish column.
The VIX closed over 13% above its 10-day moving average today. That has lead to significant market outperformance in the past, with the market returning about twice a random return in all time periods up to 30 days over the past three years.
The 10-day TRIN is now oversold as well, with a reading of 1.41. An even moderately oversold reading tomorrow (anything over 1.50 or so) will push the moving average over 1.50, which is commonly accepted to be a significantly oversold measure. I have also found it to be predictive of at least a short-term relief rally.
I stated in the weekend commentary that if the VIX and TRIN flipped over to the bullish camp this week, I personally would curtail my shorting activities. My personal methodology requires that I follow the trend in whichever time frame I'm trading (yes, I'm a trend-following moron) until such time as the risk/reward is no longer attractive as determined by sentiment extremes. I then wait for the new trend to start before entering new positions. I have no desire to tell anyone what they should or should not do, but I will mention what I am doing. At this point, I will no longer enter any short positions, for I feel the risk of an upside reversal is simply too great - much greater than the possibility of a continued downside move. In weighing the risk/reward, it no longer makes sense - to me - to concentrate any effort on the short side. This could change quite quickly, but for now that's my stance.