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Bill L.
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Methodology: setups require certain criteria to be met before trades can be executed, which include weighted statistical studies on several indicators of price, breadth, volume, and sentiment . Amount of risk taken is proportional to how many indicators are aligned. I mainly trade market... More
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  • What Does Every Market Top Have in Common? 30 comments
    May 4, 2010 1:58 PM | about stocks: SPY

    Overview:
    If you have read any of my previous articles, you know I have been a bear for a few months now. Not an easy position to take with the majority of the professionals turning mega bullish. I can sympathize with Cassandra. However, if you look at every major reversal in the stocks ever, they all have a three things in common, and stocks have achieved this un-Holy trinity; they are overpriced, overbought, and most importantly over-believed.
     

    In this article I update a few charts regarding sentiment and momentum, address the BEA GDP reading, and offer some socionomic insights.
     

    Overpriced:
    In my previous article I wrote how PE ratios had reached 22 times earnings using the Robert Schiller smoothing method. Historically, once PE ratios reach these lofty levels going forward the 10 year return is …<dramatic pause> about a whopping 1%, with a high probability of negative returns during the holding period. If measured by either PE ratios of dividend yields, this is historically one of the expensive stock markets EVER (See my previous article for more details).
     

    The Bureau of Economic Analysis released their latest reading on GDP, showing the US economy grew at a annualized rate of 3.2%. This should not come to a surprise to readers as I pointed out in my previous article that more sensitive readings on the economy such as the Consumer Metrics Institute’s daily growth index had already shown a contraction. The CMI’s data shows a very sharp contraction, so expect future revisions to be in the downward direction closer to 2% annualized growth rate. Furthermore if the lead time remains consistent, next quarter’s BEA reading of the economy should show a GDP growth rate of 0% to -1.5%. Not exactly a V shaped recovery. Even if the argument is made that this is the normal growth rate of the economy, and thus the economy is healthy, PE ratios are not “normal,” as discussed earlier they are at one of the most expensive multiples ever. If PE ratios were to contract to a normal level (say a multiple of 15), with earnings remaining constant, that would imply stocks should fall 30% from today’s prices. Prices are likely to fall even further however since it is very unlikely that earnings will remain constant if stock prices are plummeting.

    Overbought - Momentum
    Another indicator I have been monitoring is  the relative strength index or RSI, and it to has reached levels not seen in years. A reading above 70% is typically considered overbought leaving the market vulnerable to a correction. The Nasdaq Composite recently had an astonishing daily reading of 82.5%. On a weekly basis, the Nasdaq recorded a reading of 76.2%, once again a reading not seen since the bubble in 2000 and far above the 67% reading of the 2007 all time high in the other indexes.
     

    Chart 1 – Nasdaq RSI – Weekly -Overbought


    Over-Believed – Investor’s Intelligence

    In my prior articles I have outlined the combined technical, fundamental, and macro-economic case for the continuation of the bear market. So the question is when the market will actually turn down. Looking at previous market tops, the most telling sign of a downward turn has been one sided, wildly optimistic sentiment. Many of the various gauges of sentiment that I track are now in that range.
     

     

    Investors Intelligence compiles a variety of extremely useful information; data that can be used to gauge sentiment of market participants.
     

    Chart 2: Investors Intelligence Percent of Bearish Respondents

    -Data compiled by Investors Intelligence, chart created by Market Harmonics, edited by myself.



    A chart I’ve shown previously, but have updated, we can see the percentage of bearish poll respondents jumped after the selloff in January- February, only to hastily disappear again. Percentage of bullish poll respondents has also quickly soared, now over the 50% danger threshold. At this point, one and all are optimistic and confident; few people are expecting any kind of correction, let alone another leg down in a cyclical bear market. 
     

    Over-Believed – Put/Call Ratio

    Chart 3: Put to Call Ratio + 5 Day Moving Average

    -Created using Indexindicators.com, edited by myself

     

    Another updated chart, we can see that we recently had a reading below .50 meaning people are making more than twice as many upside than downside bets using leverage. This is a much lower reading in my previous article, in fact it is the lowest reading for the entire rise since March 2009, and one of the lowest readings in the last 10 years. We can see that the relentless buying of calls has moved the 5 day moving average below two and a half standard deviations from the one year mean, which at the very least in the near term has previously signaled conditions ripe for a correction. I would also note that the 10 day and 20 day moving averages are also at extremes.
     

    Beyond the Put to Call ratio, I feel another subject that has gone largely disregarded is volume. You may be thinking, “I have heard many commentators talking about the low volume, and that has not seemed to affect the market’s performance.” True, but what I am referring to is the record setting volume in the options markets. Again, another paradigm of the topping process; speculators have rule over the market and do not even wish to own stocks anymore, but instead wish to make leveraged bucket shop bets on the movements of stocks. A few weeks ago in Larry McMillan’s daily research letter, he noted that he had seen more than double the volume in options trading on several hundred stocks, the quality of which he could only describe as “eye popping.” Looking at the list myself, I honestly had never heard of more than half of the companies. In short, breadth and volume have been contracting on the stock exchanges, a hallmark of a trend running out of steam, yet people are now taking incredible risks, betting big on the most flee bitten dog stocks there are.

     

    Some Other Observations - Socionomic Insight:

    And now for something totally different...

    As a socionomic exercise I like to pay attention to trends in fashion, art and music. What stands out in my mind is the recently released and Billboard top ten hit, “Telephone” by Lady Gaga. It has been absolutely striking to see the contrast in her last several hit music video singles. While “Telephone” retains her generally upbeat pop-dance style, the video does not take place in a glitzy Miami mansion, surrounded by scantily clad Adonis like models, such as in her 2008 hit “Poker Face.” “Telephone” instead depicts a decrepit prison, holding cell and a rundown diner. Gaga dances energetically, if not angrily, to scenes of sodomy and violent prison fights. The last scene depicts a mass murder were Gaga poisons the food at the dinner, dooming all the patrons to an agonizing death. She then dons an American Flag bikini and continues shaking her stuff in front of the recently deceased. The contrast can even be seen in the titles of her albums, her first album released in 2008, “The Fame” –produced in a bull market, and her follow up “The Fame Monster” – produced in a bear market.

    Still, music has remained relatively upbeat  and generally positive tone (looking at the top ten list), but the direction in trend appears to be down. The tone of the top ten list is not as upbeat and is devoid of any “bling” videos, where wealth, jewelry, and prosperity are shown off in a casual manor. The settings for dance music has become house parties rather than in exclusive clubs, etc. Once popular music is dominated by louder more aggressive music such as the heavy metal or gangster rap of the late 80’s early 90’s,  the stock market should be much more attractive in terms or reasonable prices.
     

    Closing Thoughts:
    People often say that picking a top is a fool’s errand, and to some extent I agree. However, what I believe is quite possible is to outline a “zone” in which reversals are very likely. As you can see from these updated charts many of the indicators that I follow have gotten even more overbought. The higher, the more overbought, and more over extended these measures I have outlined become, a reversal becomes more and more likely, and right now we are firmly in that zone.



    Disclosure: Long SPY puts. Long BGZ.
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Comments (30)
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  • Author’s reply » 5 day put call ratio moving average beginning to look extended, however, this moving cannot yet be counted as complete using Elliot Wave analysis. Furthermore there are no divergences in momentum indicators and breadth remains strong to the downside with no letting up. Staying short (or long the BGZ) until the 5 day put call ratio turns and a divergence appears.
    6 May 2010, 12:36 PM Reply Like
  • Good string of comments by you here Bill, thanks.

     

    Wes H.
    8 May 2010, 12:15 PM Reply Like
  • Author’s reply » Put/Call Ratio 5 day SMA is just touching 1 standard deviation from the mean, trends tend to become exhausted at 1.5 standard deviations from the mean, so this move could run on till Monday or Tuesday. Still, trading discipline has required me to take half my BGZ off.

     

    In terms of breadth April 16th, April 27th and May 4th all saw increases in downside breadth and it has yet to let up on down days. Again, no divergences or signs of letting up. Momentum on hourly charts have yet to sport any kind of divergences.
    6 May 2010, 12:47 PM Reply Like
  • Author’s reply » Well... that was certainly exciting...
    I'll post something at the close and take a look at internals, breadth, etc.
    6 May 2010, 03:00 PM Reply Like
  • Author’s reply » 5 day SMA on the $CPC very close to an oversold signal. $NYMO has also pushed to oversold levels, however both typically turn or show divergences before a turn, and right now there are neither.

     

    Furthermore, if the market has changed direction, both of these indicators use moving averages to calculate standard deviations, and thus oversold levels. So if the market has changed direction, as I have been warning for months now, the old oversold levels are no longer valid.

     

    I took some short positions off today, but my long term bets are still on and my trading bets via the BGZ are still on. There are no divergences and this move cannot be counted complete using Elliot Wave analysis. Trading strategies should now shift; look for places to sell rather than go long and trading opportunities on the long side should be as small as possible or avoided completely if you are not a full time trader.

     

    In short, it still looks like we go lower from here.
    6 May 2010, 05:52 PM Reply Like
  • Your posts have been very informative. Good job and thanks.
    6 May 2010, 09:18 PM Reply Like
  • Author’s reply » Thank you lower98th, I appreciate the kind words. I'm just trying my best... I feel strongly that we are on the precipice of a dramatic fall similar to the false recovery and subsequent collapse in the 1930s and if I can save a couple of people's retirement savings... well... Keeping up with the blog will be worth the headaches, effort, and constant barrage of hate mail. Unfortunately today proved that our modern financial system is no less fragile (than the 1930's) despite all our wondrous technology and "regulations." In fact the speed at which our market's can collapse are probably only even greater.
    6 May 2010, 11:31 PM Reply Like
  • Bill you are spot on. Having been through the Texas oil bust 1986 through 1992 I've seen this movie before and it will have the same ending. Most people don't have a clue. Side note to this is that the banks have all this on the other side of their balance sheet regarding bad home loans and they are not talking about the next shoe to drop will be the CRE market. On top of this the current administration doesn't want a resolution trust company (the RTC) like we had in Texas for 5 years to auction off all this. I have been writing my senator and my Rep for a year and a half in Texas to tell them we have experience and can help and have gone through this before. They agreed with me but it's like no one else on the hill wants to admit we have a major problem. Keep up the good work you get it. This thing is going to unwind rapidly and when it does timber.Thanks in advance. Pinto
    8 May 2010, 12:48 AM Reply Like
  • finally some put options and leaps pay off ..after months
    when is the best time to sell options and leaps?
    any recommended article or link appreciated
    8 May 2010, 05:14 AM Reply Like
  • Author’s reply » The SEC need institutions of a certain size to use this device when trading to avoid "fat finger traders."

     

    www.youtube.com/watch?...

     

    Problem solved. NEXT!
    6 May 2010, 11:24 PM Reply Like
  • Author’s reply » Very choppy market action today, Advance/Decliners and UpVolume/DownVolume have been VERY choppy oscillating between flat to near record negative levels. Overall in my experience Choopy = Correction = The previous trend will continue = Down.

     

    The put call 5 day will be hitting 1.5 standard deviations today if the $CPC closes here, which previously has happened near the end of a downward corrections for the last year. $NYMO also one standard deviation from the mean, but with no divergence yet. I will see where these close by the end of the day, if big divergences appear that will be the first warning of the down trend pausing. When the 5 day SMA $CPC changes direction I will exit trading short positions, but for now holding short on both long term and short term buckets.
    7 May 2010, 11:35 AM Reply Like
  • Author’s reply » It's about 8pm on Friday and after watching everything settle the picture remains mixed, but I am still leading towards even lower levels again on Monday. $CPC 5 day SMA and $NYMO are at oversold levels, but neither are diverging yet, which is common during the final decline in a sequence. Furthermore, my current interpretation of today's action looks like a contracting triangle, which is a continuation pattern. A break below the Friday's low in the triangle should signal another leg downward (to at least Thursday's low).
    7 May 2010, 08:20 PM Reply Like
  • Author’s reply » Triangle is out the window and breadth is VERY strongly positive. Divergences often happen at the end of a sequence, but not always unfortunately. The first correction in a sequence is usually very sharp, as is the action today, however we are already at the 61.8% retracement level... Lets see where everything settles, but the odds shift pretty dramatically if a retracement breaks the 61.8% retracement level in my experience.
    10 May 2010, 10:25 AM Reply Like
  • Author’s reply » The 5 day $CPC SMA has yet to turn, though it did closed down slightly but still in the very oversold territory. The $NYMO also turned but so far has yet to produce a divergence, which is common in the last move of a sequence. Breadth was very strong finishing at almost 19:1 adv/dec. However the one day ADV/DEC oscillator went form over sold to over bought in ONE DAY! So a very mixed picture. Most indexes are already at the 61.8% retracement level, is if this is a new leg down the rally should be losing steam and reversing somewhat soon. If it does not and reclaims the 78.6% retracement level with the $CPC 5 day SMA turning, then I will at least in the short term be trading on the long side.
    10 May 2010, 05:06 PM Reply Like
  • Author’s reply » This morning the market looks as if it is finishing the last segment of a C wave in an ABC correction. The 5 day put call ratio SMA is oversold but has STILL yet to turn, so there is still no trading set up to buy. That being said the market is over the 61.8% retracment level and quickly approaching the 78.6% retracement level. Breaching this level will shift the probabilities, favoring that a new leg higher is in play.
    11 May 2010, 12:43 PM Reply Like
  • Author’s reply » The level I'm watching in the SPX is 1177 and 1183. 1177 is what appears to be the fourth wave extreme if this is indeed the first impulsive wave down. That is a very common target of retracements, a rise higher than this level again will change probabilities that this is the start of another leg lower. 1183 is what I have labeled as wave 1. A breach of this level eliminates this retracement being wave 4. So a breach of these levels will basically swing probabilities that we will have another run to new highs. Obviously it would have been preferably to buy lower, but my short term trading strategy is dependent mostly on the $CPC, $NYMO, and breadth. These, especially the 5 day sma of the $CPC suggest if we breach these levels there is a lot of room left to run higher in the next two-three weeks, so I will be watching very closely where it closes today.
    12 May 2010, 11:23 AM Reply Like
  • Author’s reply » I would also mention that this is right below the 50 day simple moving average which should provide some resistance. Obviously a break out above this level will tilt things again to the short term bullish side of the ledger.
    12 May 2010, 01:20 PM Reply Like
  • Author’s reply » The 50 moving average did act as resistance and seemed to repulse stocks. I think the right move is to still favor the short side. I ignored a buy setup in the Put/Call ratio because the most logical elliot wave labeling was highly suggestive that another leg lower was on deck. Furthermore the "flash crash" as people are calling it, if this labeling is correct I think the May 6th flash crash lows get taken out... and that's a lot of Dow Points. As I write this, Down volume has been outpacing up volume at a ratio of 30 to1, where are the ratio was only 22 to1 on the day of the crash. So in terms of breadth today is actually worse than May 6th. Stay tuned for an update after the close.
    14 May 2010, 01:22 PM Reply Like
  • Author’s reply » Yesterday's internals were actually negative despite the reversal into positive territory, meaning there was still more decliners than advances and more down volume than up volume. Furthermore the one day advance decline line had become one day oversold so a pause was warranted. That being said my current interpretation of the charts say that this current up move should be nearly complete and I am expecting another move down to start within the next day or so.
    18 May 2010, 10:12 AM Reply Like
  • Author’s reply » Not sure if I will write a full article, but I am now looking to sell the US Dollar and Gold, and go long the Euro.
    18 May 2010, 03:48 PM Reply Like
  • Author’s reply » I am watching the advance decline line moving average crosses very carefully here. This system generated a buy signal in early April 2009 and has not generated a sell signal yet, telling you to correctly stay long through out the several corrections we have had. If this reverses and generates a sell, for the first time in over a year, it should be significant.
    19 May 2010, 11:09 AM Reply Like
  • Author’s reply » Also, we are testing the 200 day moving average, obviously a close below the 200sma would be another negative for the market.
    19 May 2010, 12:02 PM Reply Like
  • Author’s reply » The decline/advance ratio as well as down/up volume ratios settled negative for the day, but were not as strong as the previous few days. Furthermore the 5 day SMA $CPC is nearing a short term buy signal which is being confirmed by the 1 day Advance/Decline line. This has me at somewhat of an impasse. I ignored a buy sign correctly several days ago right before the 700 point rally. Although retraced, this might again be signaling a small long side trade for the next 2 days or so. I ignored this setup because the best Elliot wave interpretation was for lower prices shortly ahead, which they are again

     

    So to summarize, the down trend in the short term is weakening, and some indicators are setting up on the long side for the next day or so. My guess is we rally tomorrow, possibly the day after as well, before again decline to new lows below the flash crash intraday low. I am currently considering whether to buy the BGU tonight in the after hours and selling tomorrow on the open and setting a stop at today's lows. But this is very risky as "oversold" levels that I have been using the last few months may no longer be valid if the trend is now down.
    19 May 2010, 06:26 PM Reply Like
  • Author’s reply » As I said yesterday, there was a pretty convincing buying setup on some indicators, but I ignored them because the best Elliot chart interpretation was showing a severe decline was in the works. I was contemplating a long position yesterday but was uncomfortable doing so with Elliot wave analysis showing a powerful third wave lower was possible, and now of course I am glad I ignored the buy setup.

     

    OK, let's get right to it, and this is important:
    BOTH DOWN/UP volume AND DECLINES/ADVANCE ratios are WORSE than during the "flash crash," so technically this decline is more powerful and more technically significant. Furthermore, breaking the 200 day moving average, something stocks have not done for over a year, also paints a very bearish picture. As I started to speculate, ALL the old setups we've been using should now be put on hold because oversold levels will now be different, now that we are in a down trend. The ONLY trading setup I will be using is looking for upward reversals that look complete to short sell. I will either be disregarding buy setups or only putting very little at risk if the setup is very convincing.

     

    Bottom line: we are going lower... a lot lower. Sell everything.
    20 May 2010, 12:52 PM Reply Like
  • Author’s reply » Busy tonight so I'll just say this: Down/Up Volume ratio was an astonishing 73 to 1. The Flash Crash was a mere 21 to 1. I am ignoring all buy signals. I am short and in cash. The only opportunity on the long side I see is the Euro Futures or the FXE. We are oversold here, but in down trends oversold markets just get more oversold.
    20 May 2010, 08:00 PM Reply Like
  • Author’s reply » Typical... just typical.

     

    Updating my commitment of traders spread sheet this morning, and surprise surprise....

     

    The small retail speculator is even longer the es S&P mini contract despite the horrendous losses in the last few weeks. Talk about catching the falling knife. Meanwhile the large speculators i.e. hedge funds who started going net short back in January has been covering reaping a nice profit.

     

    Sorry but the small guy is almost always wrong. Don't be that guy.
    25 May 2010, 01:29 PM Reply Like
  • Thanks for keeping this commentary going Bill, your indicators have been spot on and are much needed quantitative assistance to my own analysis, mostly based on index volume patterns and sentiment. I've been proclaiming for weeks that retail investors have hardly sold a thing and are doing more doubling down than selling, but everyone convinces themselves they're a contrarian nowadays and buyers will always find ways to justify buying things.

     

    Thanks again and best of luck
    25 May 2010, 02:09 PM Reply Like
  • Author’s reply » Mid-day breadth is strongly positive, with about 5 to 1 advances to declines and up volume to down volume. However, the last strong positive day (about 9 to 1) was completely reversed in about 3 days or so. There is still no daily divergence in the $NYMO, and while a divergence does not have to happen, it has happened so often this last year at lows that one should look for them. Regardless the lack of divergence and the strongly negative downside days that have been gaining steam suggests that the positive days are in fact the corrections and the trend remains down.

     

    That being said I view this as a correction of the leg down that started on May 13th. There is a gap on the hourly charts at 1,114 to 1,110. Corrections tend to want to fill gaps, and this gap happens to be right between the 61.8% and 50% retracement levels. That's the initial target, so this correction can go on for another 1-2 days. Will update after the close.

     

    P.S. -why isn't "retracement" in the seeking alpha spell check dictionary? Annoying!
    26 May 2010, 12:26 PM Reply Like
  • Author’s reply » Probably going to start a new blog entry for the ongoing commentary as this is getting filled pretty quickly so look for that.

     

    The market is up strongly on good but contracting breadth. The up:down volume ratio started off at 40:1 on the opening but as come in by half at about 20:1 at mid day. I would note however that the May 10th 30:1 day was reversed in 3-4 days. The fact that this was reversed so quickly suggests the market has changed direction and strong positive are no longer kick offs but exhaustion.

     

    I am still looking at this as a correction and the target is the opening gap I cited yesterday between, 1,114 and 1,110. The 61.8% retrace level is just above at 1,120 or so. If this is correct the rally should continue for another day or so before resuming downward. A challenge to the May 12-13 highs will mean this is incorrect and I will have to rethink what is playing out.
    27 May 2010, 02:24 PM Reply Like
  • Author’s reply » Also I forgot, there is a small gap between 1,124 and 1,121. Gaps like to get filled before a trend resumes so this is another likely stopping point (very close to the 61.8% retrace level... so some confluence there).
    27 May 2010, 02:29 PM Reply Like
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