New SDS Trade

As of this morning the short-term S&P 500 model is overbought. This is occuring at a lower level than the last true overbought signals which gives a high probability of success for bearish trades in the form of inverse ETFs (SH, SDS, BGZ, etc). Also volatility has declined so much that it is not taking huge moves to get these short-term signals now. Without further commentary......

Trade Recommendation:

Buy SDS today 12/31/08 with a market order. The current price is 71.68 which I will use to track the trade results.

Also, the last trade on QLD was stopped out if following the stop on this blog. However, I always try to post the exit purely according to the indicator as well for comparison. I would take this signal as an exit for that trade.

Pete

Gold, Grains, and General blah

Click on Chart to Enlarge

The chart above is of GLD which is an equity/ETF tracking gold prices. Today gold prices made new highs for the month modestly exceeding the highs from several sessions ago. However, the closing price was below those prior highs. For those wanting to see a continued advance in gold, this is a warning sign that buying interest at new short-term highs may be waning. Also, there is a strong RSI bearish divergence in the recent peaks. Watch the trendline of the RSI indicator over the next several sessions. Most times this trendline will break in advance of prices breaking the same trendline and can give another early warning that the trend is ending. I checked the continuous futures chart of gold prices and the analysis is the same as on the ETF. Also the MACD indicator is in a historically overbought region.

Click on Chart to Enlarge

This chart is DBA which is an ETF that is composed of soybeans, corn, sugar, and wheat. Like most commodities, it has fallen sharply this year. I have looked at the most recent commitment of traders data and the configuration for the underlying commodities is similar across the board and it shows the commercial traders (typically smart guys) buying these commodities to an extreme level. Also, speculators have greatly reduced their positions which is good from a contrarian point of view. I would interpret this as a bullish set-up for a trade on DBA. The problem now is that the short term technicals are overbought. Interested traders may be wise to wait for a pullback on short-term indicators before considering a trade.

Short-term models for the S&P and Nasdaq are basically neutral currently. It would be nice to get both those models to an extreme one way or another soon to set-up another index ETF trade. I am almost equally willing to take bullish or bearish trades at this juncture, with a slight bias toward bearish short-term trades due to many factors discussed in recent posts.

Pete

Sentiment Surveys and the VIX

Click on Chart to Enlarge

In recent posts, I have noted how put/call ratios, the VIX and VXV, and blogger opinions are getting to ranges that have had bearish implications in the past when looking ahead a couple months.

One piece of the sentiment puzzle that I have not mentioned here in a while is related to investor sentiment surveys, which can be extremely useful contrary indicators. There are several classic surveys followed by investors, but if I had to pick a favorite it would probably be the American Association of Individual Investors (AAII) survey. This survey tends to fluctuate quickly enough to make it very useful for intermediate term trading.

I find this survey to be most useful as a contrarian indicator used to trade in the direction of the 200 day moving average. Since the 200 day moving average is pointing lower now, this basically means that I would use a statistically high bullish % in the survey to initiate bearish trades. Since October the bullish opinion has been rising but us still not even 1.5 standard deviations away from the 1 year average. However another 1-2 weeks of rising prices and a break above the 920 level of the S&P 500 would likely raise this bullish % to statistically meaningful levels in my opinion. Most other surveys are still very neutral or are near pessimistic extremes, so I feel that there may not be enough of a sentiment shift back to the optimistic side to push the market lower just yet.

Another thing I watch closely for timing major market moves is the VIX. I look at the VIX in several different ways from oscillators to trendlines to bollinger bands to retracement % to Elliot Wave patterns and even a rather unique (I think) running tally of higher highs or higher lows since a significant market top or bottom.

Since the November market lows the VIX has made 8 lower lows. Anything beyond 12 and flags go up for a potential reversal. Based off this system, I think the VIX could drop a bit more and the market could rise more before we get into the danger zone.

Also I have noticed an almost uncanny tendency since the 2006 VIX lows for the VIX to retrace 78.6% (roughly 80%) of any major VIX advance. The chart at the top of the page shows the VIX with several retracements of this nature. A 78.6% retracement of the VIX advance from August 2008 lows to October 2008 highs would place the VIX at roughly 35. This happens to be the VIX level that repeatedly capped VIX advances in 2007 and early 2008. So we could have a case where old resistance becomes new support.

Peace, Love, and Merry Christmas to all!

Pete

A Number of Reliable Indicators Giving Warnings

In the last informational post I noted that the VIX (expectations for volatility the next 30 days) had dropped below the VXV (expectations for volatility the next 93 days) by about 10% as indicated by the VIX/VXV ratio dropping to about 0.90. That has been a reliable indicator of near term stock declines during this bear market. Because of the time frames of these volatility indexes, I would expect the next 1-3 months showing further stock declines. This might be a good time frame to look at for option traders (that is, Feb. or March expiration).

Now after this past week, a whole bunch of indicators are starting to give warnings that stocks are overextended to the upside. This is all occurring without the classic type of buying thrust that typically indicates a bear market is over.

In months past I have mentioned that a 10 day simple moving average of put/call ratio data is one of the most trustworthy yet simple ways to gauge market sentiment. Recently the total put/call ratio showed a reading that was stretched relative to standard deviation bands. Now after this week, the 21 day moving average is looking similarly stretched. This is a ratio that does not get stretched often, but when it does, it pays to pay attention. The last comparable readings were October of 2007 and May of 2008, both being major tops.

I won't go into every measure that is showing bearish warnings, because the tried and true ones (in my book) are telling enough. But there is another interesting piece of info that I thought I'd mention. The link below shows a chart and graph quantifying the outlook of the blog world's view on market expectations for the next 30 days.

http://tickersense.typepad.com/ticker_sense/

The interesting thing is that the data suggest a more prolonged period of net bullish blogger opinion than any time since the poll's inception a couple years ago. These blogs are well respected and influential blogs. Bloggers took a major bullish consenus the week of the crash into Oct. 10. Despite the blog world remaining very bullish since that time, stock prices have continued to basically drift sideways to down in volatile fashion since then. In my opinion, this bullish sentiment is out of sync with the reality of prices. This survey is not one that has been around for years, and it is something I only occasionally look at, but I would assume that it would be useful as a contrary indicator in the same manner of classic investment advisor surverys.

For longer term investors, I would think that waiting for a major break of the 2002 bear market lows in the Dow and S&P would be wise before making longer term purchases. Maybe the 5000 level on the Dow and 500 level on the S&P would be times to make major multi-year or multi-decade investments (assuming things actually fall that far).

Pete

QLD Trade Update - Stop Placement

Based off of the price pattern in QLD right now and due to the info in the last post, I suggest a stop placement on QLD which will allow it to move higher if it does, but for any one in it by my earlier recommendations, the potential loss will be minimal.

Recommendation:

Place a "stop loss" order of 26.30 on the open QLD trade.

Pete

Volatility Signaling that this Rally Is Running Out of Steam?

Click on Chart to Enlarge

The chart above is a chart of the VIX with standard Bollinger Bands around it. Also below the chart is a 10 period RSI of the VIX. I don't know how many people use traditional technical analysis on the VIX, but I have found some basic indicators to give timely warnings.

First, note that the VIX has touched its lower bollinger band. Since the VIX and the markets have strong inverse correlations, low VIX readings tend to correspond with market tops. The RSI is indicating a level of oversold VIX more so than any time since early May before the steady crush lower from mid May to mid July. I have a simple system for looking for VIX extremes that I have posted about before. That system is still a few lower VIX days away from really being in the danger zone, but I would heed the current VIX levels as a warning that this rally is long in the tooth.

Click on Chart to Enlarge

The chart above is a chart of closing VIX/VXV ratios with standard bollinger bands overlaid. Please follow the link below to the VixAndMore blog as that is where this indicator ratio originates.

http://vixandmore.blogspot.com/search/label/VIX%3AVXV

The chart above does not show intraday lows, but I wanted to show a smooth view of the data that is easy to identify extremes. This ratio is nearing the 0.90 level and its lower bollinger band which have proved outstanding warning signals for soon to be market declines.

Taken together these data certainly should tell us to be on the defensive, or start to get aggressive with bearish trades.

Because this data is raising red flags, I may arbitrarily suggest exiting the QLD trade initiated yesterday before any signal comes from the indicator, or I may suggest a stop loss to use to exit the trade if the market turns south. In the past, trusting the indicator has proven the best strategy, but for real life trading, risk management is the most important part of successful trading.

Pete

New QLD Trade

The short-term model of the Nasdaq is just a hair's width from oversold as I type. Based off of a few post-FOMC meeting studies and the gap support from Tuesday, I think this oversold signal has a good chance to work well.

Trade Recommendation:

Buy QLD before the close today or tomorrow morning with a limit order of 27.00. Current price is 26.74 which I will use to track the trade.

Pete