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Thursday, September 12, 2002  9:13 PM EST

I left off yesterday saying that I didn't see anything that would have me interesting in the long side of the market.  That is now beginning to change.

The STEM.MR model has cycled back up to positive territory as of the close tonight, as did the intermediate-term Composite model.  The last time the Composite model was this high was September 5th, the low of the most recent mini-rally.  The one component of the model that it holding it back from becoming extremely oversold is the advance/decline oscillator.  I stated this weekend that because of the see-saw market we've seen over the past couple of weeks, it'll be difficult for this indicator to become really oversold OR really overbought because the average drops a large negative reading one day and a large positive reading the next.  Another week will have to go by before a sustainable trend is likely to take over this indicator.

The intraday cumulative TICK indicators on both the NYSE and Nasdaq are becoming quite positive.  You can see from the chart on the site that the past couple of times the NYSE indicator has reached this level of oversold in the past month, it has lead to decent market performance over the very short term.  Over the past year, when the NYSE cumulative TICK indicator troughs under zero, it has resulted in above-average performance in the S&P 500:

We can see here that when the TICK indicator forms a low in negative territory, it has resulted in above-average performance over the very short-term.  The indicator is now below zero (-211 to be exact), so we need to wait for a reversal before being able to consider the table above.

The Rydex fund flows continue to be a positive development, as the flow into the bearish funds and out of the bullish funds continues.  Yesterday, every bullish fund saw outflows while every bearish fund saw inflows (except for a very slight drop in one of them).  This has brought the 10/50 moving average deviation on the bullish funds very close to bullish territory, and we're already there on the bearish funds.  It is plain from the charts on the site that similar fund flow activity over the past year has been a positive for the market over the short- to intermediate-term.

I've stated a couple of times recently that we've been seeing a sift in sentiment in the options pits whereby the poorly capitalized equity options traders were becoming more optimistic than the better capitalized index options traders (I'm making some sweeping generalizations here, I know, but the relationships hold up over time).  This has caused the spread between the OEX put/call ratio and the total put/call ratio to grow, which is a bearish development.  The spread is still widening, and that's certainly something to keep our eyes on.  In the meantime, we can see from the chart below that the OEX put/call ratio itself is not near a bearish extreme.  Over the past couple of years, when the 10-day average has peaked over 1.70 or so, it has coincided with market high points.  Likewise, when it meanders under 1.0, the market usually outperforms in the short-term.  We're neutral at the moment, with a reading of 1.23.  So although the spread between these two groups of traders is widening, the underlying levels of the ratios aren't yet troublesome.

I mentioned in the model change alert this afternoon that I was seeing a large amount of institutional put selling in the S&P 500 options.  In fact, a huge 45% of back-month put options went off at or below bid.  For those of you unfamiliar with options, back-month refers to all options that expire after the next expiration, in this case everything that expires in October and after.  This is notable, especially since total volume was rather high.  Complicating matters, however, is the fact that the futures rolled over to the next expiration month (December), and we may be seeing simple portfolio adjustments.  When we consider that commercial traders are short a large number of S&P futures contracts, the fact that they may hedge those short positions with short puts gives some reason behind today's activity.  The last futures rollover also saw a large spike in S&P 500 put option activity on the day of the rollover, so I'm not sure how much weight to place on today's seemingly bullish (on the surface) activity.  Also complicating the activity is that it appears as though one institution was the seller of a large number of the contracts, with a total value of over $35 million.  This is only an educated guess on my part, but it looked like a coordinated sale across strikes.  While I prefer not to dwell on the "why" of our indicators, sometimes it pays to dig deeper when we see unusual activity.  Today's activity was quite unusual, and I don't think it's as bullish as if taken at face value.

In the very short-term, we have some positive factors lining up as discussed above.  Just as earlier this week I suggested that short-term traders look for strength to sell, now I think the best risk/reward scenario would involve looking at weakness to cover shorts and go long once price begins to recover.  If we have a gap down open tomorrow, I think it may be wise to look for a quick reversal to the upside.  If we have a slow, steady drift down, I personally would wait until the STEM.MR model went into strong positive territory before looking to go long.  Remember that next week is options expiration week, and as you can see in the Seasonality section of the site, pre-expiration week has a consistently positive bias.  Also, from the Daily Market Bias section, September 17th is historically a pretty positive day for the S&P (that falls on Monday this year).  So if we have a weak Friday, chances are decent Monday will show some strength. 

Wednesday, September 11, 2002  9:47 PM EST

I suggested yesterday that short-term traders may be best served by using strength to tighten the reins on any long positions while further investigating possible short positions.  Hopefully, some of you were able to use the opening gap up this morning to adjust your positions accordingly, as the early push soon faded.

Even with the 13-point decline in the S&P from the opening highs, the STEM.MR model is still in strong negative territory.  Not only that, but the STEM and Composite models moved into neutral territory at the close.  This is odd, since the disappointing follow through from the opening gap would normally spike some of the shorter-term sentiment measures.  The levels they are at now is almost indicative of a gap DOWN and reversal UP, not the other way around.

Similar to the late August high, we're beginning to see a sentiment shift in the options markets, with the total put/call ratio (dominated by small money traders) dropping in relation to the OEX put/call ratio (dominated by arguably bigger-monied traders).  This tells us that small traders, who are consistently wrong at market turns, are becoming more optimistic than their smarter cousins.  Obviously, this is not a good sign for continued upside, although the spread is not near a level that could be considered historically extreme - just something to keep our eyes on.

Most everything else I follow is neutral at this point, so the only directional bias I can say sentiment is suggesting is continued downside.  I don't see anything that would have me interested in taking long-side positions in the short-term.

Tuesday, September 10, 2002  9:10 PM EST

I mentioned last night that if we get enough of a rally today or tomorrow to bring the STEM.MR model into negative territory, then it may make sense to tighten stops on long positions and look for shorts for a trade, with the understanding that we are at an emotional juncture so it is best to keep positions light and stops tight.

The negative indication from the STEM.MR model came this morning near the exact high for the day, and there was enough of a move down for nimble traders to capture some profit.  The recommended tight stops should have prevented giving much of it back as the afternoon spurt higher pushed the indices close to the highs.

Throughout the day, we saw heavy call selling by professional traders in the S&P 500 options, which is keeping the put/call bid/ask bias ratio very low and very bearish.  You'll recall that the last time we saw such heavy call selling was August 12th, which preceded a quick 20 point drop in the S&P.  August 12th was the day before the Fed decision on interest rates - an event that kept implied volatility artificially high.  That was one of those unusual days where even though the market slid quite heavily, the VIX actually declined.  Tonight we face the anniversary of September 11th, another event which is perhaps inflating volatility levels.  Professional traders know that when uncertainty is lifted, implied volatility levels drop.  They knew that prior to the Fed decision, and they know that now.  That's about the only reason it makes sense to sell call options so heavily.  If these traders were bearish under normal circumstances, they would go long put options, since a drop in the market would normally increase implied volatility levels and give them a double whammy gain.  Now that we have a one-day event ahead of us, they probably feel that if the market drops, implied volatility will NOT increase like usual, but will instead drop once this anniversary is past.  So if the market drops or even rises a little bit, they can still profit on those options due to the expected drop in volatility.

Many of you have requested that I include the Rydex mutual fund asset flows in the site, and beginning tonight I have incorporated them into the stable of indicators.  You will notice four new indicators on the site relating to this data set, and I recommend each of you check them out, as I believe they will be of help in determining when trends may have extended themselves.  There are two indicators which measure the flows into bullish and bearish funds, weighted by the leverage those funds employ.  Those flows are then compared to the entire asset base of the funds and a bullish and bearish percentage is calculated.  I take a 10-day moving average of each of those ratios and compare it to a 50-day moving average.  For the bullish funds, when the 10-day average is stretched above the 50-day average, that suggests that these traders are betting on further upside and they aren't likely to get it.  The converse is true when the 10-day average is 20% or so below the 50-day average.  The same concept applies to the bearish funds, only in reverse.  All of these bullish and bearish flows and ratios can get confusing, so I boiled it down to one simple indicator that takes into account all of the necessary information - the 3-month stochastic of the bullish ratio.  The indicator computes a bullish ratio (bulls / (bulls + bears)), then just compares that reading to each of those in the past three months.  Simple, but very effective.  Since we have a limited history for this data, the levels of significance may have to be adjusted as time goes on, but over the past year and a half, when the stochastic reaches .70 or more, it has been wise to use caution on long positions and increase shorting activity.  Alternatively, when the stochastic drops under .10, shorts were generally in trouble while long-side trades had a great risk/reward ratio.  You can see from the chart (included below) that this indicator is not perfect, as it was premature at the July lows, like most other sentiment indicators.  Other than that early signal, the others have been effective.

We can see from the chart that the current situation is rather positive from an intermediate-term perspective, as the large inflows into the bullish funds in late August have dissipated, and we are now seeing a rush into the bearish funds.  This activity has pushed the stochastic below .10 and into bullish territory.

The short-term picture for the S&P and Nasdaq does not look terribly attractive, but the intermediate-term situation appears brighter.  I believe that for short-term traders, using strength to tighten stops on long positions and investigate short candidates once price fails is the most prudent course of action.  Longer-term traders may want to wait for weaker prices before stepping up purchases, but I don't think it will take much of a selloff to create a situation where the risk/reward will favor the long side for an intermediate-term trade.

Monday, September 9, 2002  10:16 PM EST

A quick administrative note:  you can now see the Nasdaq 100 Commitments of Traders charts on the site, due to popular demand.  I haven't found much use for this data, and try to keep those to an absolute minimum, but I have received an overwhelming number of requests asking for it.  You can check it out in the Indicators section of the site.

I mentioned this weekend that I would be watching to for the 10-day TRIN to begin its reversal from the 1.65 level.  Since 1966, such a reversal from this level has been a very positive omen for the market, over every time frame up to 60 days, as the chart below shows:

The percentages above and below the bars are the percentage of time the market was up or down, respectively.  So, for example, 10 days after a reversal from 1.65, the NYSE Composite Index was up 64% of the time, with an average gain of just over 6.0% compared to an average loss of under -3%.  All of the statistics are just background - the most important thing to realize is that this indicator is suggesting strongly that higher prices are ahead, and historically it has been quite accurate.  Like I said in the weekend commentary, though, oversold TRIN readings in a bear market are less effective than in a bull market.

After a series of bullish readings early last week, the S&P 500 put/call bid/ask bias ratio switched to bearish tonight.  This indicator is constructed by observing trades going off at or below bid and at or above ask for both puts and calls to determine where an institutional bias may lay.  If institutions are buying calls and/or selling puts, it is generally bullish for the market and will result in a high bias ratio.  If they are selling calls and/or buying puts, it is negative and will result in a low bias ratio.  Tonight's reading is low, and similarly low levels are highlighted on the chart below, going back to late July.  We can see that the OEX (and S&P by extension) had a difficult time gaining any ground after such bouts of bearish option activity.  I don't have enough data to attach a high level of significance to tonight's reading, but it suggests caution.

I mentioned in the weekend commentary that after such high NYSE intraday cumulative TICK readings as we were seeing, the market has a high probability of being down in the VERY short-term, which it was today.  Today's early weakness did a great deal to alleviate that pressure, as the cumulative TICK indicators are now generally neutral and not telling us much.

The light volume today was troubling, as we had similar light-volume rallies on 8/9 and 8/26 that quickly failed.  This week will be something of a wildcard with emotions running high due to the September 11 tragedy.  I don't think one should discount the psychological impact this anniversary may have on our friends in New York (and around the world).  We may see market action not related to anything other than emotions regarding this event.  It's impossible to predict what may happen, as there could be everything from simplistic patriotic buying to selling on fear of a repeat attack.  This has been analyzed ad nauseam, so I don't care to harp on it, but I think we need to remember that this will have an impact on trading this week, and it would be wise to keep positions light or at least have tighter-than-normal stops.

We are a bit overbought on a short-term basis, and close to some potential resistance in the broad market averages.  If we see enough strength tomorrow or Wednesday to bring the STEM.MR model into negative territory, the best course of action may be to tighten your stops even further on long positions and possibly look for some good shorting opportunities for a trade.  I don't think we have enough of an overbought situation right now to consider the short side as high-odds, so I will be awaiting an edge in one direction or another before becoming aggressive.

- Jason Goepfert