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One of our best calls in recent years was the
October 10th, 2002 reversal that led to a 37%
rise in the overall markets. What did we see that
allowed us to make this call?
To bring you back, from August 22nd through October
9th, the Dow was down 20%, the S&P 500 sold off
21% and the Nasdaq slid 22%. All the people on
CNBC were talking about the end of the world and
doom and gloom. You could not find anyone positive
about the markets. However the indicators we follow
were telling us the downward move was coming to
an end.
In its simplest form, sentiment indicators measure
extremes in the market. When everyone is going
one way, odds favor a shift in the opposite direction.
The indicators we follow are the put/call ratio,
newsletter writers, the VIX, the "magazine
indicator" and NYSE vs. NASDAQ volume ratio.
All of these indicators flash warnings signs at
extreme levels in the market and give you a hint
of the coming reversal.
Put/Call Ratio
Typically investors will buy call options when
they are optimistic on the market. Conversely,
they will buy put options when they anticipate
it will fall. The put/call ratio measures the
number of puts bought for every call bought. For
example, when the indicator measures .67, this
is telling you that for every 1 call that was
purchased, .67 puts were purchased. This would
tell you that generally, people are more bullish
than bearish. When the put/call ratio spikes over
1.0, a warning flag is raised. This indicates
more people are becoming bearish, which usually
happens AFTER the big drop. It tells you the market
is nearing extremely oversold conditions. The
put/call ratio hit 1.12 on 9/18, 1.08 on 9/19,
1.05 on 9/20 and 1.0 on 10/9. Only two other times
in 2002 did the ratio measure over 1.0! By following
this indicator daily, you would have been alerted
to the change in direction that occurred October
10th. Use the put/call ratio as a guide only.
It is a SECONDARY indicator. In other words, just
because the ratio hits over 1.0, don't buy the
market like crazy. The indicator will give you
a good idea of when the selling is nearing an
end for the near-term, but not the exact point.
Newsletter Writers
Investors Intelligence is a company that tracks
popular newsletter writers across the country.
They originally thought if most writers were bullish,
it would be a good sign to be in the market. After
years of studying these writers, they found the
opposite to be true. In other words, when most
newsletter writers were bullish, the market soon
thereafter fell. When most writers were bearish,
the market soon rallied.
So we watch the ratio of bullish to bearish newsletter
writers to look for extremes. Let's look at some
examples:
~ In 1987, 61% of advisors were bullish up into
the crash in October. You know what happened next.
~ In 1990, during the recession, more than 55%
of writers were bearish. The Gulf War started
and the market had a tremendous run.
~ In 1994, right before the markets made another
multi-year run, bearish sentiment was 59%.
~ In February 2001, after the huge drop in 2000,
newsletter writers were still bullish. A full
62% of them, a 14-year high, expected the market
to rise. They were in for another year of negative
returns.
~ Care to guess were the newsletter writers were
on October 9th, 2002? You guessed it, mainly bearish!
Follow this number daily. These extremes do not
happen very often, but when they do it is yet
another quiver in your cap telling you the market
is about to reverse.
VIX Indicator
The VIX is a measurement of volatility. Very simply,
it measures the tone of selling which can get
panicky near market bottoms. When the indicator
moves above the 40, and especially above the 50
level, the market is very close to reversing direction.
How did this indicator perform around October
9th?
~ 9/19 46.16
~ 9/24 45.38
~ 10/04 46.28
~ 10/07 49.18
~ 10/09 49.48
As you can see, the index started creeping up
in late September and finally capped out around
the 50 level. The selling was obviously extreme.
Knowing this number, combined with the put/call
ratio and the newsletter indicator would be a
major indication to you the market was about to
reverse. By the way, it hit 49.04 on 9/21/2001
right before the markets staged a major 30% comeback
rally.
Magazine Cover Indicator
This indicator is more difficult to monitor but
simply be aware of the covers on magazines. The
writers report the news after the fact and are
notoriously late. Once you start seeing bears
on front covers and charts depicting crashes,
simply be aware. The worst is probably over. The
most famous example of this indicator is Business
Week's article titled "The Death of Equities"
which was published August 13th, 1973!
NYSE vs. Nasdaq Volume
You will notice around major market bottoms, the
NYSE will trade many more shares than the Nasdaq.
Why does this happen? When a bear market starts,
investors will sell shares of more speculative
companies first. Later in the process, they will
come after the blue chip types of companies thus
causing the volume to increase on the NYSE. The
first time we saw this indicator pop up was on
9/24 about 2 ~ weeks before the reversal October
10th. It showed up again on 10/04, which was the
highest level in over 5 years! It finally showed
itself on 10/07 and 10/08. These were major clues
of the coming move.
Following these indicators daily will help you
"feel" when the market is in extreme
territory. You will be alerted before the crowds
of the coming reversal and can position your portfolio
accordingly.
This article courtesy of http://www.investment-index.com.
You may freely reprint this article on your website
or in your newsletter provided this courtesy notice
and the author name and URL remain intact.
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