Markets rise when
the preponderance of participants are buyers, and fall when the preponderance
of participants are sellers. One of the key ways to anticipate the
pendulum swings of participant behavior, and therefore price behavior, is to
evaluate sentiment. Sentiment, more than fundamentals or technical
analysis, trumps everything.
When too many players
are on the same side of a trade they eventually find themselves in a crowded
position where most everyone around them has the same motivation – to
reverse their position when the tide changes.
Little by little,
as participants slip out the back door by changing the bias of their
position, the pendulum of price swings more sharply against the remaining
herd in the crowded trade. Inevitably, something akin to panic sets
into the herd as they begin to aggressively reverse their position for
financial survival. The primary ingredient that causes price to
catapult, up or down, is sentiment oscillation and capitalization from one
sentiment extreme to the other.
An astute market
technician, investor or trader will look for those flash points where
conditions are ripe for a market reversal. It sounds easy to do, but
remember that when the analysis is very convincing, the preponderance of
market participants will disagree. It seems that to be effective
at market timing one needs to listen not to what others are saying, but to
what the sentiment data represents as truth.
With these
thoughts as a foreword, let’s see what the current sentiment situation
is for the SP-500.
The following
chart is from Market-Harmonics and
assimilates 4 years of bull/bear percentage data from Investor’s
Intelligence. To this chart I have measured and
notated in blue the percent change in bearish advisors per the
Investor’s Intelligence data, for each downswing of the SP-500.
My notation in green is the percentage change in bearish advisors for the
related upswing of the SP-500. The price of the SP-500 is notated in
black at each swing peak and trough.
One of the most
striking observations I have made of this data is that it appears the maximum
pendulum swing in the bearish direction is a 20% change. This occurred
in Q1, 2008. More frequently this percentage change has topped out at
19%, followed by 16%, 11% and smaller percentage changes.
The obvious
conclusion I come to is that our current bearish % change situation, at a 19%
reading, is about at the maximum. History seems to show that
investor’s emotions, like a physical rubber band, can only be stretched
so far into pessimism (19-20%) - the bearish direction - before they snap
back in the opposite bullish direction.
The pendulum
swing in the bullish direction is about to begin at this very time.
I would expect
that the stock market could not possibly peak until the % of bears decrease
by a minimum of 8%, and more statistically likely 10-15%. With a
current reading of 36%, I am suggesting that we should not even consider a
peak in the stock market until the bear percentage reading drops from where
it is now at 36% to 28%, and more likely to around 26-21%.
What this means
for now is that 1100 is not the top in the SP-500. Far from it.
The bears have not even begun to turn into bulls. Price
will go much higher from here and it will take weeks, if not a couple of
months, minimum, to reach a shift where the % of bears are themselves finally
out of whack on the teeter-totter.
Gold, while not
covered by Investor’s Intelligence to my knowledge, would appear to be
in a similar setup as the stock market. For this I turn to data
published this past week at Schaeffer’s Investment Research and
look at the 2 year history of the GLD put/call option ratio.
When the put/call
ratio spikes high, it means that traders/investors are convinced that
the price of gold will fall. I have circled on the chart such instances
from the past two years in red.
What we can
observe is that when the bearish trade gets excessively crowded, when a
preponderance of participants are convinced that gold will fall, that is not
the top in gold. Rather, it is the bottom. I have circled
with green the price of gold for each occasion of a put/call ratio spike.
Again, think
about what is going on here. When the put/call ratio spikes upward you
have an intense perception and emotionally dramatic conviction of traders
that substantially puts too many folks on the same side of the trade.
When gold starts to move against them, even just a little out of their
expectation range, each owner of a put option is no longer a seller of
gold, but becomes a motivated buyer of gold! This is precisely
how huge brisk run ups in price are both setup and then executed.
If I were
presently short gold and looked at this chart it would send shivers down my
spine. No kidding. Nothing like finding out you are in a
crowded trade that once it starts to go bad, you KNOW it will go very bad.
Now, I am not
saying that the bottom for gold is in just yet. Gold could still
delight the bears and frustrate the bulls with one last brief maneuver lower
this week. But after that, if it happens, I believe gold’s
low will most definitely be in and then there will be a lot of folks who will
wish they did not hold puts on gold.
While gold has
not yet told us if the last shoe has dropped, the GDX miner ETF, however, is
suggesting a favorable outcome. The following daily chart is the GDX
and below its price movement is the True Strength Index Indicator (TSI) with
volume. You can make you own chart and use the TSI indicator by
visiting FreeStockCharts.
On the negative
side for GDX, the True Strength Index indicator reading is still barely below
ZERO in negative territory (-0.06). On the positive side, GDX is
sporting a positive divergence between price and the indicator, a recapture
of the uptrend line begun last February, a breakout of a 4 week price
downtrend line and a breakout of the TSI indicator on increasing positive
volume. All in all, I regard this setup as bullish for GDX and most
likely for GLD, as well.
If you are
interested in reading more about the techniques of using the True Strength
Index (TSI) indicator, want to be exposed to discussion and analysis of
various mining stocks, as well as the US Dollar and stock markets, or just
want to participate in a blog where your thoughts are heard and responded to,
I invite you to join me at my website which is: The TSI Trader. Or jot me
an email, tsiTrader@gmail.com
I wish you a
profitable week!
John Townsend
The
TSI Trader
John
Townsend invites you to visit his website at www.theTSItrader.blogspot.com. He usually offer a few posts
each day on his market observations, often comment on the particular
stocks he is currently trading, and tries to show ways to use the True
Strength Index indicator to make some sense of where the precious metals and
their miners are heading. Please do not hesitate to contact him.
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