Put Call Ratio - Fear creeping back into market?

The put call ratio has been one of my favorite indicators. It started to fail toward the end of the bear this year and not giving as reliable signals, but it looks like it may be coming back into play.

As you can see in the chart, the put/call ratio had bottomed out below its long term lower support of around .85 puts for every 1 call bought on the options market. The indicator is now in an uptrend and is quickly climbing back into its 2008 average range of around 1 to 1 puts to calls. This could be telling us that the market is becoming more fearful. On the chart I have also drawn vertical lines at market tops and bottoms. Historically this ratio has helped call these tops and bottoms as you can also see on the chart. Also, you can see that the indicator shows where ultimate fear occurred, which was in the October decline. It is rare for the market to be so complacent as it was the last 3 months, which could be a sign that the rally wasn't going to have the kind of fear it needed to continue indefinitely.

If this market is about to fall again, I expect this ratio's moving averages to approach the 1.25 puts to calls resistance as it did at previous bottoms.

Volume Analysis and 2009 top warning?

Update July 29 2009: Volume is now at a level that previous tops have occurred. This may be a warning that going long right now is a risky endeavor. Click on blog post to see updated chart.

Attached is a volume chart I created to spot tops and bottoms during the 2008 bear. I decided to update it thru today to see what it shows...

As you can see since late March the volume of the total market has been declining as price went up. This is not a good sign for the market. Sustainable rallies occur when prices rise on increased volume, not on lower volume. What this is showing is that more people are losing interest as this market climbs and that any decent sized wave of selling can take the market lower pretty easy.

During the 2008 bear previous tops were confirmed when the 10,12, and 15 day moving average of volume approached the 1200 level on this chart. Unless volume picks up in the next few days as the market rises, we may be in a topping process right now.

On a positive note, in Early March the rally produced volume that was consistent with all the major down legs of 2008 (hitting 1900) showing that the rally was for real.


Watch the 1200 level on this chart. If prices start to fall as this volume curls up below the 1200 level, the rally may be confirmed over.

The title of this blog links to the live chart...

Learning from old charts; Hindsight Analysis

I have attached a chart of the Dow Jones Utility Average. This chart I created a few years ago to track the relationship between Utility stocks and Bonds. The old saying goes that the two move in tandem with the thought being that Utilities are highly levered and their prices move in tandem with bond prices. However, the chart evolved into more than that once the credit crisis hit in 2007.

You can see where I have drawn the vertical black line my original chart and annotations in blue and black on the left from early 2009 and prior. Everything to the right of the black line and in pink and green are the annotations I added today.

There are a lot of things we can learn from this chart that may also help us find the top of the current rally and retracement expectations for the Utility Average.

I will first speak of the original annotations and what they foretold...
1) Probably the most important thing on the chart is the very bottom text box that stated "Divergence will show bottom". Markets are notorious for showing momentum divergence from price at turning points. This is supplemented by the fact that third waves in elliott wave theory are almost always more powerful and faster than fifth waves; essentially thirds have more momentum. So, when I labeled that a divergence would show the bottom earlier this year, I was expecting the MACD to fall again but not make new lows even though the market should make new lows. Without a MACD divergence, it is usually not a good idea to call for a major bottom (or top), and even though the market was down almost 50%, there had yet to be a divergence and thus an ultimate bottom. This led me to believe there would be another fall in prices, before downside momentum had been worked out.

2) The Head and Shoulders top I saw back in June of 2008 was spot on. The target was hit 2 months after the breakdown and continued on to a parabolic fall. Head and shoulders are pretty mainstream now, but they still can work if all the correct rules are followed. This one worked wonderfully.

3) The triangle over the 2008 winter on the Utilities helped to count the waves of the overall market and also point to another decline in stock prices. Triangles are consolidation patterns and when prices break out of them, they are often in the direction of the original trend (which in this case was down). In early February when prices broke down, that was a sign the market was on its way to new lows.

I just pointed out three prime examples of a sub market within the larger market helping forecast the next move in the market's prices. Now, I will try to use what the chart is saying to project where this next rally could potentially end.

1) After bottoming in March, the Utilities have bounced in a countertrend rally up over 20%. That is significantly lower than the markets in general which are up over 40%. So, right there we have underperformance of the Utilities which means they may not be a very good sector to put money in to catch this bounce. However, they also did not fall as much during the bear, so they could be considered a safer, less volatile sector.

2) I have counted 3 complete moves in Pink from the March bottom to A. at $358. Typically countrend rallies will retrace to the fibonacci zone of 38-62% which right now is still 15% higher in the $390 zone. From an Elliott Wave perspective the 3 part move up to A. is satisfactory for the countertrend move. We will have to wait to see how prices pan out before we can tell if that A. is part of a larger A., B., C. (which the fibonacci retrace zone tells us should be true). If the utilities trade above $358 then that would be strong support for a move to $390.

3) Typically countrend rallies following a move with a triangle in the previous 4th wave will retrace back to that triangle. So this move should theoretically retrace back to the triangle (in black) region. At $358 it has sufficiently done that. However, the triangle also has territory in the $390 price area, so there is more room to go, if needs be.

Overall, this chart was a big help during the crash of 2008. It forecasted the initial fall with the head and shoulders top and breakdown, it showed no divergence at the October lows forecasting another move lower (which occured in Feb/Mar), and it now shows the potential for a move up to $380-$390. A move below $325 may mean this rally is complete, but right now all signs point to another move higher.

Market Update Email 4-12-09

To: Friends and Family
Subject: Market Update 4-12-2009

It has been awhile since I have sent out an update. I apologize I have been busy moving and wrapping up my current job. This summer I will be focusing entirely on the markets, which I eagerly look forward to. I am also working on a market neutral trading strategy which I intend to take to B school with me and use as my focus for my entreprenuership concentration and see where that takes me. Still very early in that process though. I am living with my parents until July at which point I will move downtown to start Ga Tech.

Another reason I haven't sent out an update lately is because frankly I am not sure what to do next. The market hasn't exactly behaved as I expected. This rally up has gone farther and longer than I anticipated and a lot of the traditional indicators I use are not helping. I currently have some trapped April puts that I will no doubt lose some money on, but I am not too worried as that was the house's money I was playing with. That is what I get for trying to pick a top, though. The smart money management thing to do is to wait until a trend has formed, know at what price you will be proven wrong so you have your stop loss, and then get on board to ride that trend and get out if proven wrong. The key is to know at what point you are wrong and currently for me that point is $875 which we have not hit yet. The moves that we are currently dealing with are huge by historical standards at 20%+ each, so there will be plenty of time to jump on board something for the ride rather than trying to pick a top or bottom. I have spoken over the last month of the bounce I expected and then the sell off that will occur afterward. Currently we are still in that bounce and still awaiting the sell off. That expectation remains albeit now with a different outcome until the market takes out $875...I will show you why in the chart.

This continues to be a traders market and I don't expect that to change anytime soon. There is nothing wrong with holding cash and waiting this thing out. Most people wish they'd done that over the past 10 years; it would have returned you more! You don't have to be in stocks and Im not convinced the risk is worth being in stocks.

Now to the charts. You may have to tweak the zoom or sizing of the chart. I apologize-I added some other indicators to the bottom. I mentioned that I am going to take a hit on my April puts, but the reason will most likely be because they are options instead of stocks, and they have an expiry. This market will fall again, and most likely to the mid 700s at least, but when? I do not know at this point. Everytime I think this thing is getting long in the tooth, something happens. A good wave analyst I follow has coined this rally, the "upside surprise" rally. It sure appears that way. There are some counts that have this thing just about topped out though, but I will not try to pick this top.

The last chart I sent out expected a bounce, which we got. The bounce I expected was supposed to be a lot smaller though and end in the "red zone". Attached is what the primary count now looks like it wants to be. That 5 wave decline I had in Green on the last update, was correct. Only it seems it might be of one degree higher, and the triangle I had on a previous chart topped out in February as I now have updated again on the attached chart instead of January. That satisfies the wave structure. What this implies is that if that five wave move down in February was of one degree higher, then we currently COULD be in that "Big Summer" rally I have spoken of before (Our primary Wave 2 up).

I emphasize COULD because until $875 is taken out no rules have been broken and we could also still be in wave 2 of a 5 wave move down still. If you scroll down on the chart you will see this scenario in the 2nd section. That is why I cannot get long yet. It is looking more and more unlikely, but nevertheless, cannot be ruled out. Most likely we have started that big summer rally, and if so, we should still get a very good opportunity to get long on this next move down to below $800 (whenever it occurs). The way I will be playing this is if we break north of $875 soon then I will put a few slugs north knowing that a correction will be due sometime soon at which point I will add more longs for the next leg up knowing that when that is complete I will be shorting again for another huge move down to new lows (at Blue 2.). That next move north should reach at least $950.

Other thoughts: Remember we are in a bear market until proven otherwise. Even with this 25%+ rally we still have not made higher highs and lower lows. I do not think chasing this rally is the right thing to do, not yet anyways. On the contrary the VIX has finally confirmed the move up. It finally broke down on Thursday which typically means the market will rally, but I wouldn't be surprised to see this as a false move sucking in the bulls one last time since this indicator has been screwy for the last 6 months. I will need to wait a few days to see if it holds. The put call ratio also continues to give no signal, which is disappointing, as it was one of the great indicators of the last 2 years. The nasdaq continues to lead which is bullish.

And, finally, weekly volume has been slowly declining over the last 4 weeks which is bearish. And finally of interesting note, Goldman Sachs has announced they will be making a multi-billion $ share offering in the next few weeks. This will dilute the heck out of their shares. In theory companies should issue shares at price highs and buy back shares at price lows, so this could be a way that Goldman is kind of "calling the top" in the market. Conspiracy theorists are suggesting the banks have built this false rally in order to prop up their prices so they can get the maximum amount of $s for their offering (ripping off the share holders and retail investors). It wouldn't surprise me, and it will be interesting to see how this is spun in the news. Is it positive because GS wants to get out of bed with the govt and pay off its cheap govt. loan or is it negative because it will dilute the heck out of their shares and cost way more than the govt. debt? Who knows but it will move the market.

Good luck to everyone and shoot me any questions you may have. Remember, you know best about your current financial situation and I only use money I can lose to trade with. This is not advice, just letting you all know what I am up to since you have expressed an interest in the past.

I may be turning slightly bullish but not until a good pullback.
Chad

Market Update Email 3-16-09

To: Friends and Family
Subject: Re: Market Update March 11 2009

One sentence tonight...I bought puts this morning and expect to only add to the position. One chart tonight...the COT (Commitment of Traders) chart continues to show the only ones buying this market are the little guys and in fact the commercial hedgers and large investors (hedge funds/institutions) are increasing their shorts and have been since the January bounce. I want to be on the side of the big boys. Keep listening to that CNBC and you will go broke.

I will remain short unless $775 is taken out, then I will have to reevaluate. The key will be what happens in the fibo area of $735 to $711. Good Luck things could get bloody again.

Market Update Email 3-11-09

To: Friends and Family
Subject: Market Update March 11 2009

This is a quick update tonight as I am traveling in Baton Rouge this and next week for work. The bounce is finally here!!! I expect at least one more push higher and then it may be complete. This bounce will be similar in nature to the January bounce in size and power.

I have updated the chart and attached it. We are currently in the red zone I had laid out, so that means I will start buying some more puts for this final push lower. This will be an aggressive trade that I wouldn't necessarily recommend as this final move down will be really open ended...meaning it could be a very small move not making new lows, a large move to new lows (expected), or something very puzzling and erratic...who knows. All I know is right now the count is incomplete and we need another leg down to complete the big move down from Oct 2007. I will know more once it starts to show itself. I would use this next move to close out shorts as the next move should be a BIG multimonth summer rally.

What I do know is this rally CANNOT get above $800 on the $SPX or my count is wrong and I will have to close all my shorts and get long. That is a really long ways away, though, and I dont expect it to get close. Notice on the chart that even though Tuesday was a huge day, we still aren't even in the fibonacci retracement zone of 38-62% of this latest move down.

Heres what Im doing: Adding shorts awaiting final move lower, most likely to the low 600s, but nothing is definite and we will have to stay nimble in this volatile last leg.

Good luck.

Market Update Email 3-6-09

To: Friends and Family
Subject: Current Chart

All, it's been awhile since I sent out an updated chart, so here it is. As I mentioned I took some profits today and am frankly unsure of whats going to happen next. I still am waiting for that bounce and we have a possible wave count completion (see chart), but my indicators say we could have a lot more downside before that bounce.

Im just not sure. I will do some more research this weekend. For some reason I am not trusting my indicators. What I am sure of is we will get a multiday bounce when this down leg is over followed by another big selloff which should complete our market bottom at new lows.

The 2nd chart is one of the VIX (the implied volatility on options contracts). This is one of my indicators and it should be peaking as the market falls. The chart I built has the VIX inverted so that it tracks the market (which means it should be spiking down as the market falls). As you can see there is some crazy divergence going on now that hasn't happened this entire bear market. Why is the VIX not tanking? That is what I need to study more.

Good luck. Nothing wrong with staying out of the market when you are unsure of things.

Market Update Email 3-5-09

To: Friends and Family
Subject: Quick Market Update - Taking some profits

Just wanted to let you all know that I am taking some profits on my shorts. I still think we will see lower lows, but I am also expecting that decent bounce I have been talking about, therefore I am going to a more cash stance for now until I am able to do some more research. Currently that bounce can run as high as $775 when it does occur, but I doubt it will have that much steam. Theres a few things I must figure our first including the VIX, put/call, and relative strength of the nasdaq 100.

Im still bearish, but being the aggressive trader that I am, taking some money off the table seems like the smart money management thing to do. So, wait and see mode it is for me. I am still holding some shorts, but have closed all of my put options on the market. The one regret I may have is if this market crashes, which the VIX and Put/Call are certainly supporting right now, but I would rather miss out on that than risk my profits of the last 2 months. Besides, I am banking on that next opportunity in a week or two.

Just trying to do some money mangement for now. Send me individual questions if you have any.
Good luck.

$VIX Blog entry on Stocktock

This blog links to a blog I posted on stocktock.com...

The VIX has yet to confirm this move even though we are down 20% from the nearest high...im still trying to figure it out. either this is a gift from the put buying gods or something is up. Maybe some comments will help figure it out.

Bear market until proven otherwise!

Market Update Email 3-1-09

All, no charts tonight, but nothing has really changed. We are heading down and continue to head down hard. The bounces have been very weak and my embedded scenario is playing out (mentioned in last week's letter). The big double bottom bounce was very weak, if not nonexistent, and makes me think the bounce I am waiting for (which corresponds with the 4th wave bounce of the final 5 down) has still not happened yet. This is how I am playing it, anyways. The fact we just blew by the 2002 and November 2008 lows without a whimper is scary, frankly. There should have been some conviction of buyers there, but wasn't.

The Volatility index (VIX), put call ratios, and volume all say this decline is far from over. In fact, on the committment of traders chart, which is a chart that tracks the small speculators, large speculators, and large institutions actions, the only group of people who are net long are the small speculators. This group is always wrong about the market as a whole! This group represents the general investing public. This is also the first time since the March 2008 bounce that the only bulls have been the small speculators. This is scary, too. The VIX also has barely moved since the early January top, even though we have fallen over 20% since then! Complacency is way too high. Too many people think the bear is just about done. This is also supported by the amount of call buying versus put buying which continues to be a great indicator.

Bottomline is the wave 1 I have labeled on the Feb 20 chart last week is still applicable for all intents and purposes. We just haven't gotten that double bottom bounce with the suckers rally to the red zone. The red zone is fully below $800 now, by the way. Once that bounce occurs there will be one more ample opportunity to get short before the final sell off at least into the $600s, and most likely low $600s (at least that's how it looks today).

Tomorrow looks like it could be a bloody day.
Good Luck. Chad