RYDEX ENTHUSIASM INDEX

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APPLICABLE TIME FRAME(S):  

SHORT / INTERMEDIATE

UPDATE SCHEDULE:

Each weekday morning by 3:00 AM EST for the previous day's activity.  Rydex does not release their data until late in the evening or early the next morning, so there will sometimes be an even longer delay with this data.

EXPLANATION:

The Rydex family of mutual funds (www.rydexfunds.com) has a selection of funds that cover broad indices as well as narrower subgroups.  These funds are popular with market timers, as some of them are highly leveraged (as much as two-to-one, so for example a 1% move in the S&P would correspond to a 2% move in the fund), and the Dynamic funds can be entered or exited intraday.  The most popular funds are based on the S&P 500 and the Nasdaq 100.  Rydex makes the asset levels of these funds available to the public each evening, and by observing where these active traders are placing their money, we can get a handle on their sentiment.  While it would be a stretch (to say the least) that these Rydex traders actually move the market with their money flows, the value in the data comes from its accurate reflection of traders in general.

The concept behind this indicator is that when these traders shift money into and out of the index funds at a pace that is unusual for the amount that the market moves on a given day, then that can tip us off that traders may be becoming too aggressive in one direction or the other.  And, given these traders consistent history of being wrong at the extremes, then that can present us with an opportunity to look for a possible reversal in the market.

The Enthusiasm Index is created by looking at how much the underlying indexes (the S&P 500 and Nasdaq 100) move in a given day.  Say, for example, they both rally 2%.  We then look at how traders shift their money among the various index funds and compare it to how the NAV's of the funds themselves changed.  So, if the NAV of one of the bull funds increases by 2%, but the asset level of the fund rises by 15%, then we know that investors may be more aggressive than they "should" be by pouring more money into the fund than is warranted by its performance.  This basic concept is taken and applied across all the index funds to come up with the Rydex Enthusiasm Index.

The blue bar lines are the daily Enthusiasm readings.  The red line is a 3-day moving average of the daily readings.

GUIDELINES:

When this Index is at a high level, that shows us that the Rydex traders are more enthusiastic than they "should" be given the performance of the market.  Meaning, they are shifting into the bull funds and out of the bear funds at a pace that is unwarranted given how much the market likely rallied during that time.  Conversely, when the Index is very low, then that tells us that these traders are quite pessimistic and are leaving the bull funds in droves while piling into the bear funds to bet on further downside.  Predictably, the market often rallies when these traders have such low expectations.

The chart below shows us what we should be looking for.  Large shifts into the bullish funds on a day the market is down or up slightly smacks of excessive optimism and is generally a good sell signal.  Conversely, large shifts into bearish funds on an up day (or slight down day) tells us these traders are showing excessive pessimism and can be a good buy signal.

STATS:

*Standard Deviation.  See below...

68% of readings (1 standard deviation) should be between -.14 and .14

95% of readings (2 standard deviations) should be between -.28 and .28

99% of readings (3 standard deviations) should be between -.42 and .42

In other words, we should expect a reading under -.28 or over .28 approximately 13 times per year.  Since such a reading would be relatively unusual, it suggests that we may be seeing an unsustainable trend.  These figures assume a normal distribution curve.

ADDITIONAL RESOURCES:

Rydex funds (www.rydexfunds.com)

© 2005  Sundial Capital Research, Inc.  All Rights Reserved.