Like, WAAAY Overbought

After the big plunge on Monday and Tuesday, a lot of buying power was required to drive stocks back up. That effort has left the market in a dangerous overbought state.

If you don’t have time to study the chart below, make sure to bookmark this page and come back to it before Monday since it probably signals the end of this bear-market rally.

The chart shows the TRIN and SPY. I have put a simple 3-day moving average onto the TRIN. When the average falls to 0.80, you have a sell signal. On Friday, the 3-day moving average of the TRIN closed at 0.79, indicating a very overbought condition.

When was the last time that this indicator has hit this level? May 15th, June 25th, and July 8th. Those days are marked on the chart with blue vertical lines. After the latter two dates, the market flopped right over. On May 15th, the animal spirits of the bear-market rally kept stocks inching upward for two more days before the rally ended.

Top Section:
TRIN in light blue.
3-Day moving average of the TRIN in red.
The purple line is the 0.80 level of the moving average.

Lower Section:
SPY over the last three months.

Light blue dotted vertical lines are sell signals.

If the market is able to inch higher on Monday as it did at the end of the March-May rally, I will go all-in and leveraged-short with all of my remaining capital. Coming into the week, I was 98% in cash. On Thursday and Friday, I loaded up on SDS, SKF, and SPY puts. Those positions are all underwater now, but I don’t think I will be taking pain for much longer.

Yes, it is psychologically almost impossible to short in the face of a strong market. But I did it at the end of the March-May rally, and I am doing it again right now.

Note: It is pretty easy to make a chart like the one above. I doubt that there are any charting programs that don’t have the TRIN. So, all that you need to do is slap a moving average onto a TRIN chart and check it daily. I used a 3-day period for my moving average because SPY has been wobbling in short spurts lately, but you can adjust the period.

21 thoughts on “Like, WAAAY Overbought

  1. A couple of bank failures. Hedge fund collapsing. Vix at 18. Looks good Matt.

    The only thing that can hold it up is falling oil. But falling will soon be negative, not positive?

  2. I wasn’t near a computer during the day, I did manage to add 1 % more QID @ 39.80, bringing my allo to 9 %

    I certainly agree with the plan of adding to shorts in some way if we are at all higher on Monday at some point.

    Larry, yep a VIX in the teens again…but how to play it ? I’ve used the 25 strike for calls this year with mixed success, you’ve got big spreads to deal with for most of these…

  3. Hi After, I use VIX as my guiding technical indicator in general index ETF’s. In this bear market: Add shorts when VIX is low. Take profit when VIX max’es out.

    I don’t know how to trade. So I sit for months at a time.

  4. thx, Larry. If anyone is buying vix calls next week, details on which ones would be appreciated.

    Someone posted elsewhere that this coming Monday would be the 21st anniversary of the top that occurred in 1987 before the crash of that year.

  5. Matt:

    Have you ever tried to apply TRIN MAs to weekly or even monthly charts? I’d be very interested in hearing your results, if any.



  6. Matt – is this a “momentum driven market” – momentum = fall in oil/commodities, prospective inflation waning, Fed rescue of FRE/FNM, stable interest rates, election year, etc.?

    “In the momentum driven markets, the TRIN can remain oversold or overbought for extended periods of time”

  7. The low volume of this past week will be even lower this coming week. The market can easily rally in this scenario, no matter what the charts say. Just my 2 cents.

  8. A low volume hike facilitates distribution; we’re in no hurry to go down. A market that keeps not falling becomes a self-fulfilling prophesy, increasingly seen as evidence that we’re not going to fall. There’s nothing stopping us from going into the 1350 area. Once a sufficient number of players have been convinced we won’t fall, we will.

  9. Randall, the TRIN has been oscillating recently. Maybe that will change, but there is no evidence to support that idea as far as I can see.

    Crash, Kailash, it is not just the TRIN flashing a warning sign. Take a look at the put/call ratio. It isn’t too far from where it was at the peak of the last bear-market rally. That’s a huge red flag.

    If you make a chart with SPY and the VIX on it, you will see that a low VIX has coincided with every SPY peak during this rally. The VIX hit a rally low on Friday. Another huge red flag.

    The strong dollar has been fueling this rally, but the dollar is now very overbought. In fact, the latest Commitments of Traders report shows that long-dollar futures positions are at their second highest level in history. That stupendous level of speculation will almost certainly see a correction soon.

    While the rally could continue, I am shorting this market because the odds are stacked in my favor. At a minimum, there will be a sharp correction soon.


  10. I’m catching up with the last few days of comments. Here are a few FWIW observations.

    • Looking at the SPX we broke down out of the ascending wedge formation; the common resolution to this pattern.

    • On Friday we rose to kiss the ascending trend-line from below. This retest of the trend-line is also a common price pattern after breaking down from an ascending wedge. I’ve seen this referred to as the ‘kiss of death’. It often works out that way.

    • I was reading the Big Picture Markets blog where Bob Ferrell’s 10 rules for investing were listed. Rule number eight says ‘Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend’. That’s a pretty good rule to remember with particular relevance to the current market condition. In observing price patterns in other bear markets I’ve noticed that while the patterns of each bear market are unique, each tends to have an acceleration phase where prices gain momentum to the downside. Sometimes this is quick (a crash), at other times it takes the form a relentless daily decline. I’m thinking that we are probably very close to the acceleration phase of this bear market.

    • The supply / demand work that I do shows the rally from July 15th to be the weakest yet in this bear market. A few months from now we will look back and see that this proved to be of shorter duration and shallower than the March – May correction.

    • The fundamental background has done nothing but get worse since July 15th.

    • My experience is that you want to establish the bulk of your short positions before the next significant down-leg gets underway. Risk of failure increases if you wait until the down-trend is well established. On the other hand, timing is sometime problematic so I use either double inverse mutual funds or ETF’s. In that regard, I’ve increased my double short basis the SPX to 66% of my portfolio. It’s now likely this corrective rally is over. If I’m wrong, the top will take place sometime in the next three weeks with no more than 5% up. I can ride that out given the confidence that we have 10-20% down coming soon. I’ll be 100% double short sometime soon.

    • With regard to ETF’s, the fills are horrible. Somebody is making a bundle in the middle. Be careful.

  11. With the low VIX (which correlates with high call/put ratios) combined with low volume, the market is in a drift higher, plunge lower mode. The VIX is at a bottom, but it could still make lower lows (see May). Monday morning will likely be up because small investors may be conned into thinking Friday’s action meant problems over. If Monday is an upday by the close, then Tuesday should wipe out those gains.

    I will exit my short September positions on market weakness unaccompanied by high volume. I will add to October short positions at key resistance levels (XLF 21 or SPY 1300).

  12. Gerard,

    I agree with your comments. Since I trade options, I’d rather get confirmation on the rally’s end (volume) and the leverage will make up being late to the party. If I was strictly trading stocks and ETFs, I’d ride along with you and Matt.

  13. after,

    RE: VIX options

    VIX options can only be exercised on expiration date. It is important to realize how this affects pricing. I suggest that you look at historic option prices. Also, I’ve found that vertical spreads are low-profit on VIX, and calendar spreads can be very risky (>100% loss), so simple options postions are better.

    Currently, many options are priced expecting VIX levels in the 22-24 range. Considering that this is 25% above the current level, they don’t strike me as cheap. The VIX is a measure of S&P option implied volatility, so SPY puts ARE cheap by definition. This seems like the easier way to cash in on a market crash.

    If I can get VIX Oct 15 calls in the 6.5-7.5 range, or Oct 20 for 2-2.5, then I’ll be a buyer.

  14. David,

    One thing, is that I’m not convinced that technical charting can be applied to the VIX. The reason is that you can’t directly buy and sell it. So you can’t buy at support and sell at resistnce; you can only influence it indirectly by buying and selling S&P options. Another reason I’m skeptical is that most patterns require certain volume levels to confirm them, but VIX has no volume.

    Since highs and lows of the VIX correlate with H&Ls of the S&P, you will see some patterns on the VIX, but I’m hesitant to read to much into that.

    Also, a few days back I wrote that I thought VIX would only reach 18 this time, so I don’t think it will go much lower, either. However, it may bounce up and down and still be a point lower by Friday.

    If I could buy VIX directly at this level, I would. However, I can only buy VIX call options, which already have a big spike priced in.

    Let me put it this way: XLF Oct 22 puts are at $2.32, not a bad deal. However, if they were priced at $5, I’d look elsewhere for a trade.

  15. Fear is very low now and the air is full of wishful thinking. It’s time to gather positions, even if that means we have to wait a few weeks. The financial train wreck is coming and very few investors have gotten out of the market. Bear markets have lower highs and lower lows, we are hitting the lower high now.

    I recommend ETF’s, less trading on a daily basis and more time to other stuff. Remember that 95% of investors have lost money in 2008 and will do so in 2009 also. Don’t be too greedy, you’re already part of a privileged few who are on the right trade of this credit slope.

  16. Check out the Elliott Wave analysis at, pretty much confirms what all of you are saying about a next leg down (to WAY down).

  17. I believe the bear condition will continue until the housing market improves, and I do not see that occuring at least until mid 2009.

    So I will be adding to my SDS and SRS position at 1300 with a stop at 1303 in case it runs on to 1325 or 1350 area. Technically 1300 should be the top, but I can’t ignore how low volume days can move a market higher as well as election fever, false gov’t data, etc. to a short term continuation of this rally.

  18. Hi Everyone,

    do any of you think that the news for Obama’s choice of VP will have any impact to the market? Thinking that people might want a DEM in the whitehouse come Nov, but would that be good or bad for the market?

    IMO.. I think it will be just bad and worse for the market as I’m sure that the current presidency has so much crap hidden under the rug right now that the next Pres., regardless of party will trip over it and fall flat on their face as soon as they walk in the oval office.

    JMO though…

  19. Matt,

    could you update that chart after the close today if it’s not too much work for you? I think it would be very interesting for the rest of the gang. We are in deep overbought territory right now. If it stays there for another week I will go all-in!!! 🙂

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