Major Stock Index Selling By Smart Money

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The commercial "smart money" traders increased their selling in stock futures this past reporting period making them the most net short in over a year.  The last times they were this heavily short were at the July 2011 and May 2011 tops.  While a signal like this can fail to lead to a major correction, in the context of a double top/failed breakout I wouldn't bet on it.  At a bare minimum I suggest having in the market trailing stops on long positions or growth stocks.  Remember, our goal as individual traders is to observe what the big players are doing, anticipate what they are likely to do next, and to position ourselves with them.  So they are more bearish than in the last year or so.  Are you?

Combined with a failed breakout of the April 2012 high, this reinforces that a correction is likely from these levels.  But as noted in the recent video, it would be out of character for the market to push above the recent August high and then make a correction.  A new high would likely be a continuation point.

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Notice that the bollinger bands are squeezed tightly on SPY.  Not shown is the ADX/DMI which shows that the daily DMI has been below 20 for 2.5 months.  As it approached 20 two weeks ago, it turned down as the market failed to breakout.  Recall several posts talking about this explosive set up in the past.  Most recently it occurred in gold resulting in an upside breakout.  But the key is the watch for a close OUTSIDE the bands with both bands expanding.  When that happens in this situation it typically leads to a sharp price movement, though it may only last 1-2 weeks.

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The VIX/VXV ratio recent spiked lower again similar to what occurred in March of this year.  What this mean is that short term volatility is out of balance with longer term volatility expectations.  As you can see on the chart, that has often led to substantial corrections in stocks with on overall increase in volatility and a rebalancing of the VIX/VXV.  The other possibility is for volatility to remain low and the longer term volatility shrinks to rebalance the ratio.  If that happens it would likely be in the context of a continuing low volatility market advance.

As an additional note, the VIX has been running high relative to historical volatility.  This also often happens prior to market corrections.  The option market does not believe the current low volatility trade is sustainable.

At this point the US dollar looks set to make a continuation of its advance, and commodities have run very hot for several weeks and are likely to correct.  So I think we are likely to see a deflationary theme type sell off here again with most assets down and the US dollar up.