Trader’s Narrative

A recent mention of cumulative TICK on Trader Feed blog caught my attention and I looked at this indicator today. Now I know, Dr. Steenbarger’s chart of cumulative TICK is using the NYSE TICK data and it is very short term in contrast to my analysis.

But he does briefly mention that “…the Cumulative NYSE TICK has stayed well above May levels.” And then goes on to extrapolate:

Continued strength in Cumulative TICK would suggest to me that we’re experiencing a correction in a bull market, not the start of a renewed bear.

I’m not so sure we can draw that conclusion. For reasons that I’ve outlined many times before, I prefer to use the internal breadth data from the Nasdaq. So here is a look at a few years worth of cumulative TICK for the Nasdaq:

If a higher high is a sign of a correction within a bull market, then by that account according to cumulative Nasdaq TICK we’ve never even entered a bear market!

Now I know this is the Nasdaq data but the NYSE chart doesn’t look all that different. Which reminds me of the uselessness of cumulative breadth numbers (advance decline) as any type of indicator - NYSE Breadth Is Strong: Why It Doesn’t Matter.

Instead of looking at TICK data cumulatively, I prefer to smooth it using a simple short term moving average:

Although it has come down from the extreme in April 2009, it isn’t anywhere close to the range that has historically coincided with market lows (or lasting market bottoms).

The last time we saw the McClellan Oscillator at an extreme was in the first week of the new year. Back then, for both the NYSE and Nasdaq, it reflected a very overbought market - so much so that it was a decade high (see long term charts in previous link). We now know that the signal it provided in early January was correct as the S&P 500 index quickly reversed and fell from 940.

Now the McClellan Oscillator has swung to the other extreme and is plumbing depths rarely seen. This indicator, is of course, a measure of internal market health. It is a measure that uses advancing and declining issues in a market to find overbought and oversold oscillations.

Here’s a chart of the McClellan Oscillator (Ratio Adjusted) for the NYSE:

Since there is so much non-common stock securities trading on the NYSE these days, I always look at the Nasdaq data to make sure that they aren’t distorting the picture:

According to this indicator, we are close to a ‘wash out’ scenario in the market. And it couldn’t come at a better time for the bulls because the market is sitting right now at support. The McClellan Oscillator’s extreme low level may help the market to hang on by its very fingernails by buttressing it exactly when it needs the support most.

We are starting to see some shifts in sentiment that reflect the sort of pessimism that usually accompany market bottoms. While the Dow Jones is below the November lows, I’m not convinced because it is not capitalization weighted and it represents a very small sample size of 30 companies. I’m giving much more weight to the capitalization weighted S&P 500 index which has yet to convincingly break support.

Another possible scenario is for the market to pierce the November lows, trapping new bears and crushing them as it bounces up. Always remember that the market is no one’s friend, and it doesn’t owe you anything. In fact, more often than not, it is there to distribute the most amount of financial pain, to the most number of participants.

From recent option sentiment readings we have reason to believe that after a fantastic “Santa Claus rally” the market is entering thin air territory - at least in the short term. To that we can add an important technical indicator: the McClellan Oscillator.

If you’re unfamiliar with it, it is simply a measure of underlying breadth and is calculated by taking the difference of advancing and declining issues and then using this net breadth to calculate 39 day and 19 day exponential moving averages. The oscillator is then calculated by subtracting the former by the latter.

You can calculate this oscillator for any market and for each it will display different characteristics but usually, +100 is considered overbought and -100 oversold.

Here is the McClellan Oscillator for the NYSE:

I would take this chart with a grain of salt because over the years, a larger and larger portion of the issues traded on the NYSE is attributed to non-common stock securities like bonds, CEFs, municipal bond funds, preferreds, etc. But even so, the McClellan Oscillator is off the charts!

And this is the McClellan Oscillator for the Nasdaq:

It is important to note that this technical indicator compliments the view that option traders provide because they are both short to medium term in nature. It wouldn’t make much sense using a long term indicator, like say, the Coppock Curve to confirm a short term indicator - or vice versa.

As I’ve mentioned in recent weeks over and over again, the market is being driven by news more than anything else and we have not been anywhere near a washout capitulation. I also warned that the market has been not acting as if it is ready to bottom:

…we still have not seen full blown panic selling to completely wash out all the weak hands

In an ironic twist, Wall Street shaved $700 billion off its valuation after realizing that the US government wasn’t about to rescue it with a blank cheque for $700 billion.

I really didn’t predict today’s carnage, but I’m not surprised at all to see the Nasdaq falling -9.14%, the S&P 500 Index down -8.81% and the venerable Dow Jones down -777.68 points.

Almost every single metric known to technical analysts hit the redline. It is still too early to come to a definitive conclusion and I’m still looking at a lot of information but here are some quick facts:

During the day, volume flowing into declining stocks as opposed to advancing stocks on the Nasdaq hit an astonishing 80:1 ratio.

The VIX volatility index reached a high of 48.40% (and closed at 46.72%) to put that in perspective, that is higher than what we saw from this indicator in 1998 (45.74%)during another financial crisis.

The percentage of S&P 500 Index (SPX) components trading above their 50 day moving average fell to 9.60% - below the critical 10% threshold.

On the NYSE advancing stocks were a paltry 53 while declining stocks were 2,842. And on the Nasdaq, advancing stocks were a bit higher at 424 while declining stocks were 2,563. Volume flowing into declining stocks on each stock exchange easily registered as a Lowry’s 90/90 day coming in at 97% for the NYSE and 98% on the Nasdaq.

The only outlier was the options market. The CBOE put call ratio actually fell to 0.79 and the ISEE sentiment which measures retail option traders activity was similarly unimpressive. I have no idea why the options market showed absolutely no concern during a day like this. Very puzzling.

I can’t wait to see what tomorrow’s market brings. I’m still not convinced that we have the worst behind us but at least we can safely say that we are on the road to capitulation.

The simple bond indicator wasn’t responsible actually. Eventhough the rate of change in the bond market is both logical and fairly accurate, I still give more weight to breadth analysis.

In the first week of June 2007 we saw a curious anomaly. The NYSE advance decline numbers suddenly went haywire and spiked into extreme oversold levels. Many at the time interpreted this as they had all previous times: time to buy! But following an indicator without really understanding it can be dangerous.

In fact, the NYSE breadth extreme was due to the sharp move in the bond market which forced all the interest rate sensitive issues on the exchange to sell off dramatically. Because I keep an eye on the Nasdaq breadth numbers as well, I picked up on the divergence in the two breadth levels and wrote about how the NYSE’s advance decline numbers can be deceptive.

So I was very careful to not jump in and go long. For the most part I stayed on the sidelines and picked at a few selective sectors here and there.

Here is a chart showing the S&P 500 Index during two separate instances involving extremes in market breadth. In the first, both the NYSE and Nasdaq’s market internals spiked to an oversold level. Almost immediately afterwards the market recovered and went higher. But in the recent situation, the divergence lead to a month long meandering. Also notice how the short lived recovery in mid June failed to take out the previous swing high:

The other time we had a similar situation was in May 2004 when the NYSE and Nasdaq breadth numbers diverged. After that instance, the market went sideways and then down until August 2004. But it looks like we won’t have a repeat of that. This market is much too strong.

With the breakout we witnessed in the major indices I’m much more comfortable buying here. What gives me confidence is not only the muted sentiment but also the unflinching conviction of commercials.

I’v also noticed that eventhough we’ve enjoyed a quick ramp up in a short time, the market seems to still have a lot of kick left in it. For example, the Dow which has been leading the charge just breached 14,000 and yet only 70% of its components are above their 50 day moving average. Compare that with May 2007 when it was more like 95% above their 50 day moving average.