Friday, August 5, 2016

VIX and McClellan Oscillators Give Further Warning That Stocks Will Pullback Soon

Click on Chart to Enlarge

Short term, the hourly chart of the VIX is in the formation of a sell warning which I have highlighted many times on the blog.  VIX is below the longer term bollinger band (and the standard bollinger band) and the shorter term bollinger band is below the longer term band.  So this is a dual time frame type of signal that there is a statistical extreme or imbalance in the short term trend relative to the longer trend.

Additionally, as of current intraday values, the daily VIX value is below its lower bollinger band.  I have backtested that simple condition going back 20+ years, and there is a short term negative skew in forward SPY returns for a week or so after the signal.  Longer term, looking forward several months that signal itself is not really bearish, but the forward returns are a little muted.

Click on Chart to Enlarge

This chart is of the McClellan Oscillator which is a measure of advancing and declining issues trend.  It basically works like other oscillators in that trends will tend to turn NOT when breadth is at a peak or trough, but after an extreme followed by a divergence in the oscillator relative to the price action.  In our current environment, there are bearish divergences in the oscillator indicating that the new price highs are occurring with fewer stocks advancing than at previous highs.

Now the really significant thing I see (but without any backtested data), is that the value of the oscillator is still below zero despite the new highs in prices.  This occurred earlier this week as well.  Now, again without backtesting, I can only speak to memory of observed cases like this, but notably the Sept 2014 price high, occurred with consistent McClellan oscillator readings below 0.

So from my perspective the current environment of stalling after a breakout to new all time highs, short term divergences and waning breadth, and major "smart money" selling into the breakout, is a caution and potential for a failed breakout which could lead to a significant correction.

My suggestion is certainly don't buy here.  For short term speculation, I don't have any real strong bearish study to alert to, but from the factors I have looked at here relative to VIX and bearish divergences, it seems there is at least a mild negative skew for upcoming weeks.


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