Snapshot Notes - October 15, 2007

As of:

SPX 1545

Late last week, we got a couple of price patterns that had preceded consistent market performance going forward. Based on those precedents, it seemed likely that we would suffer a notable downside reversal on Thursday, a rebound on Friday, then more selling pressure early this week.

It doesn't always work out that way, obviously, and luck played a big part in this as it always does, but the indices stayed true to those precedents and behaved very much like the historical examples we went over.

The biases after those price patterns were consistent in the short-term only, however, and after a few days' sessions were inconclusive, so it's probably best if we stop relying on anything they may have been saying from this point forward.

More notable is that today's weakness was enough to generate some solid oversold readings among the most sensitive indicators that we follow, and it pushed the STEM.MR Models for both the S&P 500 and Nasdaq 100 into "buy" zones. During strong uptrends, that's usually about all we see before another rally attempt, and if we don't get that, then we have to start worrying more seriously about the possibility that a more lasting top may have been put in.

One piece of evidence supporting that view (that a top is in) is something I went over this morning related to small options traders. In late July, I posted a comment that discussed the overly optimistic nature of those folks, and it happened to precede a rather nasty smack upside the head. In the latest week, the data shows that those traders are not only back to their old ways, but they're actually more optimistically positioned than they were in July - in fact, they're at their most optimistic since November 2000.

That's absolutely a concern, especially when we consider some of the other readings that have been popping up in recent days, like overly enthusiastic sentiment surveys and the ratio of Nasdaq volume to NYSE volume. So perhaps we're tempting fate by going to the well again on the long side, but the major indices have still done nothing "wrong" since the mid-August lows, and typically we'll get a heads-up that the too-bullish sentiment is about to take its toll. So for now I'm going to give some respect to the short-term oversold readings and the belief that the risk/reward has tilted back to the bullish side, at least for a trade.

As of:

SPX 1545

HELP ARCHIVE

Over the past several days, I've been harping on market performance following reversals like last week. While luck had a big part to play (we'd be fooling ourselves thinking otherwise), the indices have played out the script in nearly perfect order.

Those were short-term patterns only, however, and have pretty much been played out so I think it's time to stop relying on their suggestions at this point, and try to find anything else that may provide an edge.

Our short-term guides are beginning to become intriguing here, with the STEM.MR Model for the S&P 500 at a very oversold 80%+ reading and the one for the Nasdaq 100 also in oversold territory. We're still in a generally positive market environment, so I take these oversold conditions seriously.

Also interesting is this...any time that we have seen down issues on the NYSE exceed up issues by a 3-to-1 margin on a Monday, then the rest of the week was positive 73% of the time in the history of the S&P 500 tracking fund (SPY), which goes back about 12 years. The average return was +0.9%, with an average maximum gain (+2.3%) exceeding the average maximum loss (-1.8%). That's not a huge edge, but it's also notable that this is option expiration week, which has had a pretty positive bias over the last year. Neither of those facts are enough for a trade, but combined with the short-term oversold conditions, they are moderately supportive.

This morning I mentioned that small-trader sentiment had spiked to an alarmingly high level, and that remains a definite concern. When we saw that in July, prices began falling and didn't really stop for month. So I'm not looking to go crazy-aggressive here on the long side, but the risk/reward in the short-term looks skewed to the upside, particularly if the S&P 500 is able to hold above 1540ish.

As of:

SPX 1523

HELP ARCHIVE

Good Monday morning...we begin the new week with a quiet start, before an avalanche of earnings that will pick up steam over the coming weeks. Many traders will also be keying off financial shares today after the announcement on Friday about an attempt at a self-financed bailout of some of the problems there.

In a longer-term comment from July 22nd, we went over some data regarding the options positions of small traders that had a decent history at preceding trouble in equities. At the time, I thought it was worrisome enough that that short-term would be tough going, but it was a relatively isolated reading and I was not expecting it to lead to the kind of selling pressure we got into August.

Since then, we saw those traders significantly reduce their bullish bets and actually swing a bit too far in the other direction in August. No longer, as the latest data shows that these smallest of options traders have bounced right back and are trying the same thing they did in July.

In that July comment, I showed that these traders were spending a whopping 47% of their volume buying speculative call contracts, and only 17% buying protective put options. That had changed dramatically going into late August, but this latest week shows that they once again spent 47% of their volume on calls and only 16% on puts - an even more optimistic positioning than what we saw in July, and in fact the most extreme since 2000.

Last Thursday, we went over some stats regarding the large gap up open in the Nasdaq 100, and how that seemed most likely to lead to an intraday reversal, and potentially a quite nasty one. That happened to play out pretty close to historical precedents, Friday also followed through in nearly perfect order.

What those stats were also pretty consistent in suggesting was that after a one-day bounce-back after a reversal like Thursday, we should expect more short-term weakness, at least for a couple of days. After that, there was little agreement as to whether Thursday's reversal should lead to a more intermediate-term decline or more of a rally, and I wouldn't read anything more into it other than it was consistent in leading to short-term weakness.

By Thursday afternoon, we were getting some oversold indications from our more sensitive indicators, we have had a habit of leading to new highs in the major indices lately. Such readings, coinciding with the "one-day rebound" stats, suggested that quick-fingered traders may want to try for a short-term bounce, but I felt that the consistent tendency to see additional short-term weakness after downside reversals like Thursday would override any very short-term oversold signals.

Combined with the evidence that the smallest of traders have embraced the upside with gusto reinforces that thought, so I am not looking to chase any upside attempts here especially as we begin the frenzy of earnings releases, heavily weighted with financials and widely-held tech stocks this week, and the risk of overnight gaps is at its worst.

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