Tuesday, August 20, 2013

Monday Was Not A Washout

There are a number of indicators that we track to determine whether sellers have capitulated and a durable bottom is in place. We look for at least a few (not all) of them to confirm a washout. When a high proportion are at an extreme, it's a Fat Pitch TM.

And by that measure, Monday was not a washout as only one reached an extreme.

NYMO: We have been tracking the McClellan oscillator closely. It is a very good indicator for a bounce long. On Monday it reached -100; that is an area from which the indices will normally advance higher for a few days, or longer. But note that many times a lower low will follow as the down momentum continues (red arrows).

Put/call: The options market has been subdued throughout the past two weeks (first chart) and especially during the last 4-day sell off. On Monday, calls outnumbered puts whereas fear is normally represented by a put/call ratio of 1.2 or higher (yellow shading; second chart).

Volume: SPY volume on the sell off has been light. That indicates a lack of panic and the absence of capitulation. In comparison, prior washout bottoms have come with a spike in volume (yellow shading).

Advance/Decline (A/D): Readers of this blog know that we track major accumulation days (MAD; 90% up A/D volume) and major distribution days (MDD; 90% down A/D volume). One or more MDD (red shading) indicate an evacuation of the market. It's even better when it's followed by a MAD (green shading). Down volume yesterday was 80% and today's up volume is 65%, nowhere near either extreme that marks a washout.

Trin: Also known as the Arms Index, it compares advance/decline issues relative to volume; a high value often indicates a washout as volume overwhelms issues. Yesterday, it was 1.3. Below, notice the instances where it was over 3.

There are also a few longer term measures we track into a washout. None are even close.

Bullish Percent Index: This looks at the proportion of stocks on a PnF buy signal. SPX has reached an area that has in the past marked a high point (over 85%; red dots). What is needed is for the BPI to sink at least below 50% (blue dots). Major bottoms are below 20% (green dots). Yesterday, BPI was 80%.

Percent above the 50-dma: As the name implies, this looks at the proportion of SPX stocks trading above their 50-dma. Peaks coincide with readings over 90%; washouts coincide with readings below 20%. Yesterday was 47%.

Time: Investors are naturally focused on percentage declines. That is money being lost (or won if short). But washouts are most often marked by time. A quick decline does not allow investors to turn bearish and set up a new uptrend. For example, the decline in June this year lasted just 5 weeks. The two declines in 2012 were twice as long and set up longer advances. The decline in 2010 lasted 4 months and set up the subsequent 9-month rally into mid-2011. Ideally, a decline now (which started just 3 weeks ago) lasts deep into September to set up a durable rally into year end.