Actually, let’s just recap Thursday and Friday!
–Dow – down in the region of 500 points
–S&P – down in the region of 70 points
–Nasdaq – down in the region of 100 points
Now let’s consider my last article where I mentioned why the S&P could well find itself below 1000 before long. I also mentioned during the summer how 2011 was resembling 2008 in many ways.
There’s no reason to change that view right now, and a sub-1000 S&P is looking distinctly realistic.
The OVI has been telling us something’s wrong for months now
For those of us who follow my OVI indicator, we’ve been aware that something wasn’t quite right when the markets made their impressive bounce during August.
Two things stood out.
- Volumes were weak – but we could argue that it was still the holiday season. Note that volume is a key driver of market behavior. Consider it like gas in your car’s fuel tank. If the car goes uphill without enough gas, gravity is likely to send the car back down. The same applies with the markets.
- The OVI wasn’t participating in the rally – and had been subdued throughout the summer as well.
Let’s look at the S&P, Nasdaq and Dow all together and see what we can make of them all. Note that we measure the OVI for the Exchange Traded Funds (ETFs) for these indices. (ETFs are like stock equivalents, tracking their respective indices, and trade exactly like stocks.)
SPY (S&P ETF)
Look at the impressive rally made in August – over 200 points from the low on the 9th, to the high on the 31st of the month.
But then look at the OVI.
Despite the 200 point gain, the OVI simply couldn’t get above zero during that time – not even for a day!
This was an important divergence.
A 200-point gain in such a short space of time should have been accompanied by a positive OVI, even if only for a day or two. But to limp along not even getting to the neutral line…that told me that the rally would be short-lived.
Time and time again I was writing to my private students, telling them something was amiss and that the rally was not to be relied upon.
Sure enough, on Thursday the market got the jitters. On Friday it tanked and it’s still doing so as I write this piece on Tuesday – down another 30 points on the S&P at its low point today.
Looking at the OVI for the SPY, as well as its “no show” for August, it’s had very few days above zero since May, so really, there’s no way you could have been optimistic for the S&P in recent weeks.
QQQ (Nasdaq ETF)
Up until July the QQQ’s OVI has been my favored OVI reading for the broader markets. But since July, as you can see from below, it’s been bouncing up and down, albeit spending almost all of August correctly in negative territory.
During August it popped up marginally at the end of the month, but only for one day and not by very much.
But as well as its general negativity, it’s the inconsistency it has displayed that has been the giveaway for me. The QQQ’s OVI is typically very consistent and doesn’t typically sway from positive to negative like it did in July. This in itself was a warning sign.
DIA (Dow ETF)
The DIA’s OVI is typically rather bullish in comparison with the OVI for the QQQ and SPY.
This can be seen by the way in which its OVI is “less” negative than those for the QQQ and SPY. However, it’s still very much on the negative side and it’s difficult to be bullish right now with stocks.
Well, if you don’t mind trading either direction, then you can play the markets by going short. If you only like trading long, then you may not have much to do for the time being!
But either way, you MUST adhere to a properly constructed Trading Plan (see my article from last week!)
I mentioned last time that while it was speculation, we couldn’t be too surprised if increasing volatility is the hallmark of the rest of 2011. Nothing has changed my mind on that just yet.
How To Use Good Information To Limit Losses
If nothing else, the OVI disciplines your trading choices by eliminating any possibility to be a buyer “just because prices are low.” That leaves us looking for bearish plays or none at all.
Remember, cash-in-hand is a position in itself.
The goal is to be super-selective in times of extreme volatility (opportunity for those armed with the proper discipline). High probability trading candidates in the present environment must have the tradeable chart pattern AND negative OVI for shorting plays.
Again … Remember the Trading Plan!
The broad stock market indices’ internal workings remained negative even on the last rally. The OVI insider-view of the buying and selling of those-in-the-know puts us in a privileged position to plan properly with the odds in our favor.
As the old axiom goes … Plan the Trade, Trade the Plan.
Review my previous article here www.absolutewealth.com/a-trading-plan-must-be-simple for the finer points of preparing your Trading Plan.
Just as a reminder, your Trading Plan must cover:
- Initial stop loss
- Exit with first profit
- Adjust stop moving forward
- Exit with second profit – hopefully with windfall if trend continues
The volatile summer months are coming to a close, but who knows what’s around this rather edgy corner now. Those who did not have a non-emotional indicator will be glad to see the dog days end.
But that’s not really the point. The point is this:
The markets are neither good nor bad. Most of the time however, and most importantly, they can be profitable provided you have the proper tools and Trading Plan discipline.