Sunday, January 13, 2008

What Does a Tradeable Bottom Look Like?

After many people called a temporary bottom on Wednesday following a reversal day on all indexes, the markets now look like this bounce could very well be a two-day event – not very impressive. I also felt that Wednesday could have been a short-term bottom, but looking back, I realize that there were not enough signs for it to be a true, short-term, tradeable bottom. I think the strength of the move down made me just think we had to have a good bounce soon. We still may, because technically the lows of Wednesday have still held, but I figured I should examine what signs to look for in a tradeable market bottom and why the past few days have not matched up to these signs.

#1) Stocks Up 25% or More in 65 Days is Less Than 200 as per Market Monitor.

You can learn more about this indicator at Stockbee but I will explain it briefly. The basic idea of the market monitor is to keep track of overall trends in the market, both short-term and longer-term. The 65 Day ratio compares the number of stocks up 25% in the last 65 days to the number of stocks down 25% in the last 65 days. When the number of stocks up 25% in the last 65 days gets below 200, it typically indicates a level of momentum to the downside that is unsustainable. Please check out Pradeep’s research because you will learn a ton of useful information. I believe the last time it reached these levels was on August 16 – check your charts to see what happened that day. Right now, my scans show the number at 336, which indicates we could still have a ways to go on the downside from here before getting a meaningful bounce.

#2) The T2108 Indicator from Telechart.

I have discussed this before – the basic idea is that when this indicator gets to 20 or below, the market is at extreme oversold levels. It reached this level back in August and November, from which short-term tradeable bounces developed. Right now, we are still 32 and have a ways to go to get to 20.

Chart from Telechart2007, Courtesy of Worden Brothers, Inc.

#3) Major spikes in the VIX and Put/Call Ratios.

I don’t check these on an intraday basis but I will check once in a while to see how the compare to the action in the market. For instance, I put a chart of the VIX in my last post showing how it is nowhere near the levels it was at previous bottoms in August and November. Right now, we are at 23.68. When we get up near thirty, then a short-term bottom becomes a possibility. Put/Call ratios also tend to spike dramatically at market bottoms, indicating fear and panic selling. Typically spikes above 1.0 show a lot of fear and indicate a possible turn. On Friday, with markets down almost 2% again, the ratio was 0.98 – not complacent but definitely not fearful.

Sentiment indicators such as the Investors Intelligence Survey are useful as well but since they only give new information weekly, they are not as useful as the previously mentioned indicators. However, I continue to point out that in the last survery, bears were only at 26% and bulls were still at 48%.

As a trader, I always need to remind myself that the market can and will do whatever it wants to do. It's possible we go up 2-3% on Monday. It is possible we rally for a week or two right from this point. However, because of these data points, I feel we have a much better chance to continue to go lower here without a good bounce. When the data starts to change and the above indicators get to the levels mentioned, then I will start looking for possible dips to buy for a short-term bounce. Until then, I will not be taking any long positions and sticking with shorts. I made a mistake last week by not following I saw in the above date and relied too much instead on what I thought should happen, and it cost me my positions in some shorts that continue to go down. I was extremely well-positioned but let personal emotions interfere with my trading. I hope I learned my lesson and do not plan on letting it happen again. Good luck on Monday!

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