Sunday, April 26, 2015

Complacency In Market Suggests Downside Skew Over Next 2 Months

Click on Chart to Enlarge

The chart above shows times since 7-1-2007 where my proprietary real money daily sentiment gauge was at a relatively extreme low level which correspond with Friday's level.  Notice that all of the data points occur in this bull market, and most towards the later stages.

In any case here the point is that in the current bull market, when the levels of real money fear has been this low, there has been a marked downside skew moving forward over the short to intermediate term.  In fact, over the next 2 weeks. the next month, and even over the next 2 months, the max downside was over twice as large as the max upside.

The only cluster that showed an immediate upside skew was really the May 2013 period right as stocks were breaking into a new all time high after a sideways consolidation.  That is similar in context to where the market is right now, so maybe that is significant.  But after that instance, price chopped slowly high for 2 months, and then sold off rapidly in 2 weeks back to the exact level of the beginning of the cluster of complacency readings.

Basically there are 8 relatively unique clusters within this selection of filtered data.  And only the May 2013 cluster ( 1 out of 8 ) was not a solid intermediate term exit point for stocks when looking out 2 months.

Also the average maximum gain of an at the money put was 4.5 times as great as the max gain of an at the money call.  These are with expirations exactly 2 months from the day of purchase.

The average maximum gain on the put was 150% if only buying at the first signal of a cluster and including the "loser".

Basically 3/4 of the instances increased over 100% max gain for the put.

So it seems that if the market dynamics are similar here to what they have been during this bull market, it would be a solid trade to buy the put here and set and 100% limit exit order.  Now I think that using my bottom spotting indicators the exit could be more fine tuned, but for simplicity it seems like the simple 100% profit target would be a strong positive expectation speculative play.

As an alternative, for the investor, a put option hedge could be placed here if holding a heavily long portfolio of stocks.

I am already positioned with a downside bias here and don't plan to add on this signal.  But it seems likely to me that the Nasdaq Composite will run up a couple percent and eclipse the 2000 high before a possible significant decline.  So that is another factor here to follow.  Watch for a top reversal candlestick or possible failed breakout on the Nasdaq at which point to initiate the hedge or put option.


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