On the one hand…

August 5, 20119 Comments

Calling the market in the near term right now is a little tough, given a couple of negative developments that occurred on the charts from last week’s market meltdown. Over the summer, I had been calling for a correction into the technical support area of 1250 or so for the S&P500. On Wednesday of last week, we had a nice intra-day reversal off of about 1243 to end with a close over 1250 on the day. I placed some (not all ) of the cash I have been hoarding over the summer into the markets that day–with a focus on U.S. equity. For less than 24 hours, I felt pretty smug about that move. Then came Thursday and Friday.

The S&P broke 1250 with a vengeance. Some technicians have pointed to what they feel is a head and shoulders top on that index, although I’m not so sure I agree with that prognosis. If they are correct in that formation, a measured move target would bring the S&P back to 1150 or so. Either way, a break of the support level that has held for the better part of 2011 is not good news. And of course, let’s not even talk about the break of the 200-day MA (yeech!).

However, there is a little bit of shining light at the end of the tunnel. Sentiment indicators have moved smartly into “buy” territory. The study of sentiment indicators is kind of a hybrid form of technical analysis. One must decide when to marry the two, or when to place more emphasis on the observation of chart patterns (technical) vs. sentiment indicators. The current situation brings me back to the environment of early 2009 when markets were plummeting through all levels of technical support, including the old 2002 lows. Dire predictions of Dow 1000 and S&P 100 were emerging. But the sentiment indicators were telling a different story. They were getting bullish.

So, here are just a few (there are many, many more) sentiment indicator observations that you could take into consideration when trying to determine just how far this market may have left to fall:

  • The VIX “fear gauge’ shot up late last week to a one-year high. Gason Goepfert of sentimentrader.com notes that the last 2 times this happened the markets were 8% and 16% higher respectively in the following 3 months.
  • The ISEE call/put ratio has dipped at or below the 80 level 3 times last week (once intra-day)–again a sign of capitulation and oversold conditions. I conducted a study on this indicator when combined with oversold momentum indicators such as RSI and this can be an accurate turnaround signal.
  • Speaking of RSI–its not a sentiment indicator, but went pretty deeply oversold (well into the low-20’s) during last weeks crisis. As mentioned above, when combined with a low ISEE level–its a pretty good indicator of a turnaround pending.
  • Lastly- I have borrowed a chart from sentimentrader.com. below showing the American Association of Individual Investors (AAII) survey of % bulls. Basically, sentimentrader’s work shows that when this survey shows less than 35% bulls, bullish reversals occur shortly thereafter. See the chart below, where they’ve marked these vital points.

So there you have it. A lousy technical environment but a bullish sentiment and oversold oscillator environment. Choose your team. I’m inclined to go with the sentiment indicators – I’ve rarely seen them steer me wrong.

9 Comments

  • Very interesting insight as always Keith.

    Its not easy to go against the moves of the masses, I have been playing both sides of the fence so to speak, using the VXX.TO and buying on weakness. I want to share with you and your readers my Trading Oath, which I also call my Do’s & Don’ts. Its posted next to my computer monitor, looks ugly in its 9 X 11 pale white state, pasted nicely against a teak wood background!

    My Do’s and Don’ts
    1) Trade In The Present: Do not dwell on the past or try to predict the future. The former is counterproductive and the latter is impossible.

    2) Think In Terms Of Probabilities, Not Prediction: Instead of trying to be right by predicting the market, focus on the methods in which the probabilities are in your favour for a successful outcome over the long run.

    3) Take Responsibility For Your Own Trades: Don’t blame your mistakes and failures on others, the markets, your broker, and so forth. Take responsibility for your mistakes and continue to learn from them.

    These may not be everyone’s cup of tea, but they have steered me and served me well. I find the only regrets I have is when I don’t let them guide me, especially in volitile times such as these.

    Cheers

    Neil Bowie

    Reply
    • Neil–I especially like point #2. Nobody can predict what the market will do. Nobody knows. But there are very quantitative ways to measure risk and reward. Support and resistance is one, or even fibonacci numbers (which I dont place too much empahsis on) can add to the odds of being right. Its about trading with the odds.

      Reply
  • Hi Keith,
    Thanks again for past prediction.Wish had raised more cash.
    Do you think its time to start deploying some cash to TSX & Nasdaq??

    Thanks in advance
    Muntazir

    Reply
    • Well, I am still holding some cash, but as mentioed in my blog writeup–I did spend some of it recently. I’d like to see a bounce, then retest and followup bounce to establish a bottom before committing more. But the bottom is most certainly approaching quickly. Sentiment readings are deep into buy territory. Quite frankly, the risk in the market is looking better and better. Dave’s comments here suggest 1000 on the S&P 500. A possiblitily, but given the extreme momentum and sentiment reading, not a probablity. I’m inclined to watch for a bottom any day now. But keep your cash until the bounce and retest. Best to play it safe!

      Reply
  • no doubt the markets will bounce perhaps even to the underside of the trendline that was broken on the S&P (1340 or so?). But a bit longer term I think we can get down to the 50% fib level (measured from 02/2009 to the high at 04/2011) of around 1000. I think thats where were headed. I want the market to prove to me that it can get above 1368 and stay above it. If that were to happen oil will probably be back above 100 dollars per barrel which in itself will put the breaks on any further upside. I think we need to have levels of oil somehwere in the 70 or 80 dollars per barrell (maybe even lower) for a sustained time (ie not just a few months) to get some real growth going.

    Reply
    • I am revising my target for this collapse to 1050 which is where previous big volume was. We should get a bounce there.

      Reply
      • Hey Dave–this is the precise level I mentioned on BNN interview yesterday for my worse-case scenereo. We’ll see, eh? Cash is a good thing now, whatever the case.

        Reply
  • Hi Keith,
    I would appreciate if you can post the link to your interview with BNN as I could NOT find it.Thanking you in avance

    Reply

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