Trader’s Narrative

Everyone was watching the line in the sand: 1310 on the S&P 500 and it was crossed today.

The market just can’t get any sort of rally going, even when it is recovering from an extremely oversold condition. That’s not good.

Now we’re rolling over and the only thing that gives the tape a jolt are rumors of Ambac’s salvation. But I try not to get bogged down in this sort of guessing game. I’d rather look at the indicators that have worked in the past.

Out of Breadth
I pointed out a few intriguing charts in last week’s sentiment overview. We haven’t gotten the breadth reading I was expecting: the percentage of S&P 500 stocks above their 10 day moving average bounced up from 13% instead of going below 10%.

The number of declining stocks shot up to 2800, well above last week’s numbers and those of the January low. Like everyone else, I don’t know what will happen but according to the charts, such a spike in the number of declining stocks has in the past put a floor under the market within a few trading days.

Option Traders Panic
The most obvious number to jump out at me today was the ratio of puts to calls for equities (from the CBOE). We’ve had recent instances of this important ratio (almost) piercing par but thanks to today’s abysmal market we’d have to go back farther than four years to find a more frightened option market.

For those keeping track, the number was 1.1183. Paradoxically, of course, this is good. When the market is tanking, you want people to be scared. If they’re nonchalant, a cascade lower usually follows because everyone who wanted to sell hasn’t been frightened enough to sell. Fear exhausts the weak hands and forces them to take action.

After today’s, the next highest CBOE equity only put/call ratio is from Friday, August 6th, 2004: 1.28 - a major low in the market. Pull out your long term charts and take a look.

Notice how in 2004 the put call ratio kept spiking higher and higher?

I’m pointing that out so that you don’t think it has to be contained by an arbitrary numerical barrier. What we are seeing is definitely a panic but that doesn’t mean it can’t intensify.

Most significant market bottoms are not “V” shaped. That is, the market doesn’t just spike down and then suddenly reverse up. Often times it recovers, only to retest the low. A retest, however, can be slightly above or below the previous swing low. So while we once again seem to be approaching the January 22nd and 23rd levels, I’m going to be watching my technical indicators to see how the market will react to it.