Trader’s Narrative

So after warning you that we were headed into some shaky grounds on Monday morning (premarket) when the S&P 500 stood above 1540. And after the market fell to around 1510, saying that we had still some more room to the downside… Let’s see if I can continue this streak.

Lowry’s 90/90
No question today’s market action was severe. No doubt it was a Lowry’s “90/90″ day - where 90% of the points and 90% of the volume are on the downside. From the 3417 issues on the NYSE, 3144 of them closed down. That’s 92% to be exact. Meanwhile, volume on the NYSE was 95% to the downside.

Can you say e-x-t-r-e-m-e?

This is the sort of panicked, thorough selling that market inflection points are made of.

New Highs New Lows
This week I mentioned a few indicators that I was watching. The Nasdaq’s New Highs/New Lows indicator told me that we had more room to fall as it was still above 10. Today’s devastating decline took this indicator to just below, at 9.39. At these levels we can start to seriously look for a bottom.

Today, the New High/New Low Ratio also fell to extreme oversold levels. According to these two indicators, the number of 52-week lows (compared to highs) presents a compelling argument to go long.

Leaving aside market internals, a simple glance at the chart of the S&P 500 gives us a hint that the market may find its footing here. The February 2007 top which previously acted as resistance but can now become support:

Usually I leave volume off my charts but check out the volume today! Notice how in previous market inflection points, the surge in volume coupled with a wide range dark candle tends to signal a change in trend?

Most common indicators swung to extremes: The volatility index (VIX) spiked above 23 and met my request to go a tad higher. And the put/call ratio also spiked to a bullish extreme.

But the indicator of market health that I give a lot of weight to still hasn’t reached the kind of wash-out extreme that I’d like to see:

I’d prefer to see a real washout that would be a reading of 20-something. Similar charts for other percentage of stocks above 50 day moving average for indices like the Nasdaq 100 are also low but not low enough yet.

We could still bounce from here, especially as a gap up open tomorrow morning. That’s why right after 3pm I bought a bit of Ultra S%P 500 Proshares (SSO). The last hour of trading is known as “contra-hour” for good reason

What I’m most interested in seeing is how sentiment reacts to this recent decline in the markets. If we have real fear (increase in bearish sentiment), then we are probably all clear for another leg up in the bull market. But if people are complacent and do not flinch, things could get ugly.

A reader (Pat) got in touch with me today to point out that there was something rather peculiar in the trading volumes of UltraShort S&P 500 ProShares (SDS) and the Ultra S&P 500 ProShares (SSO). If you’re not familiar with them, these are relatively new ETFs.

According to their prospecti, SDS and SSO seek daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of the S&P 500 Index.

As the name suggest, the UltraShort (SDS) ETF offers twice the inverse of the S&P 500. So when the S&P 500 goes up, it will go down twice the amount. While the Ultra (SSO) provides a leveraged bet (twice) on the index going the same way.

Although easy to ignore, since these are usually used as trading vehicles not investment vehicles, the expenses are surprisingly high at 0.95%. To compare, the SPDR S&P 500 ETF (SPY) only charges an MER of 0.0945%, or less than a tenth.

In any case, the level of activity in both ETF was very low until just at the end of February 2007, when we had the infamous Chinese mini-crash. After that, both ETF volumes perked up. But the UltraShort S&P 500 ProShares (SDS) volume increased much more. So Pat was wondering if this meant something in terms of sentiment.

Why is the trading volume of SDS (short ETF) almost 10 times more than SSO (long ETF)?

I really don’t know, but if I had to take a guess, I would say that people got really spooked when the market fell earlier this year. And maybe they suddenly discovered this new way to have exposure to the short side.

Many traders and investors who have cash accounts are not able to have short positions. But with this ETF, by going long (buying) they are in fact exposed to the short side. Almost makes your head hurt to think about it

I don’t think we can muster any sort of sentiment significance for this lopsided volume though. I consulted with a much wiser technical analyst (Jason Goepfert of Sentimentrader.com) and he agrees. He further added that instead of looking at the volume, track the assets that are in each ETF.

That way, you can get a glimpse into whether people are piling into the long or short side. And use that as a contrarian signal. This is similar, by the way, to how the Rydex Funds have been used for many years. The difference being that they are mutual funds and not ETFs.