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October 22, 2006

BWSB: Moment Of Truth
by Jay DeVincentis

Bi-Weekly Stock Barometer No. 146

Dear Subscriber,

Is something BIG is going to happen this week? Here's what we're looking for.

If you're new to the biweekly stock barometer, welcome. This article comes out every 2 weeks and gives a big picture view of the market and our recent activities. If you're interested in following our signals and learning more about our system, then I invite you to click here and subscribe to the daily service - since the market can turn on a dime and so to can our interpretation as the market gives its daily clues to the future. Or sign up for our free weekly newsletter, where we provide up to date articles from our various trading services. We're also going to be releasing a free trading video - so sign up today.

Periodically, you reach these points in the market where you just know something is going to happen. Everything seems to be culminating into a final climax and this week is going to be it.

Am I predicting an October crash? Of course not. I never predict crashes. It's really just a good way to get publicity - but you can get a reputation for saying that the sky is falling.

All I try to do is predict and position to profit from the next possible magnitude turn. This article lays out our prediction using several indicators that we've been showing for the past several years. And the market remains in an incredibly strong uptrend that we've been positioned against since 10/3 - a call that so far is not looking too good.

Crashes are something that if you're going to call, you have to be very careful.

In fact, this weekend I saw an ad from a competitor (who's much larger than I am) making quite the opposite call - for a huge rally to commence. In it, they raise the issue of open interest on VIX CALLS, saying it is extremely high right now.

This is a bet that the VIX will rise. The problem with such a big bet - is that if you're wrong, it can be like being short a rallying market, you end up having to cover these bets into a strong market and further influencing the rally.

Well, VIX Options (and accordingly, open interest) are relatively new. They started trading around March this year and that's when we started following them. So drawing strong correlations with the data is probably not the best idea. Plus, unlike the market itself, there's a question as to whether betting on the VIX can drive the market. Something we will explore over the coming months.

Whenever I hear such claims, I dig into the numbers myself. So I developed the following 2 charts. The first chart is the VIX Put Call Ratio. Now the VIX moves inverse to the Market, so when the market goes up, the VIX goes down.

However, the VIX is anti-persistent, in that it trades in a range and can't continue higher or lower than that its inherent range. I actually believe it's only anti-persistent at the extremes - and not in the middle of its movement. But that's a topic for a whole other article (or several).

So right now, with the market rallying, the VIX is at a low and the likely bet on the VIX is that it will go up from here - so you'd buy some calls - and sure, a lot of folks are. You'll note on the scale of these charts that it will not be inversed like other options charts - as all my charts are scaled in an order to best match the market.

Looking at a chart of the VIX Put/Call Ratio, you can see somewhat of a relationship between put buying and call buying and market action. I still think it will take some time for this product to develop more of a personality. But for now, it's calling for a short term top - not a bottom.

In the second chart, we focus in on the open interest by itself. Its range is much narrower than the action of the PCR, moving between 0.1 and 0.25 in this view. Again, we need a bit more data (and time) to really gage the impact of this indicator. But I believe it's best to view this like the OEX Open Interest that we view periodically. Looking at open interest, the concept is that when the writers are more willing to write calls, they're less nervous about the market falling. And they're likely wrong. Just as when they're more willing to write PUTS, they're less nervous about the VIX falling and the market, so it's more likely to rally. Spin your head a little on this one? Don't worry.

So can we draw a meaningful conclusion from this?

For now, I'd like to follow the indicators for several more months and various market conditions before drawing too much of a conclusion. I'll report back on this in the future, so stay tuned.

Let's get on to the charts.

Message From The Markets

Market action is ruled by sentiment and by monitoring market internals and studying sentiment; you can gain reasonably predict future market movements. The basis of the Stock Barometer system is overlaying extremes in sentiment with sound technical analysis to predict the likelihood of future price movement. Each indicator and chart measures the hope, fear and greed of investors and traders from different angles. Follow along with my charts and over time, you'll also learn to understand how to read the markets, which is essential prior to setting up each and every trade.

STOCK BAROMETER CHART

The Daily Stock Barometer is a proprietary measure of market energy. The direction of the stock barometer determines our short-term outlook on the market's direction. A BUY or SELL signal is triggered when the indicator clearly changes direction. If the line is moving up, we are in BUY MODE and if it's moving down, we are in SELL MODE. The black line is a 5-day moving average that we use to confirm changes in direction.

EQUITY PUT CALL RATIO CHART

The CBOE put/call ratio is comprised of two sets of data; equity options and index options. The index component contains items that are used as a hedge, thereby distorting the correlation and interpretation of the indicator. I use the equity put/call ratio. This is one of the most accurate read of investor's fear and complacency.

TRIN/ARMS CHART

Richard Arms developed the arms index. It is also referred to the Trading Index or TRIN for short. It is a measure of the ratio of up stocks and down stocks divided by the ratio of up volume and down volume. Our Spread Chart converts the arms index data into momentum Buy and Sell Signals.

TICK CHART

The tick index is represents the sum of all stocks ticking higher minus all stocks ticking lower (a stock is said to be trading on an up tick when it trades at a higher price than the last sale). It's utilized as a day trading tool as it gives you an up to the second read of the intensity of buying and selling.

BREADTH (ADVANCE - DECLINE) CHART

Each day several thousand stocks either advance, decline or remain unchanged. The number of advances and declines normally ranges from +2500 to -2500. A high number of advancing stocks normally marks a top just as a high number of declining stocks normally marks a bottom. Monitoring the 5 and 13-day moving averages of this allows us to better predict future prices.

VXO CHART

The VIX is a measure of volatility on options pricing. We use the old VIX, which is now called the VXO. The higher the volatility, the more likely the market is close to a bottom, as traders are willing to pay more premium for puts, which act as Insurance on their long positions.

Cycle Time

Monday is day 15 in our DOWN CYCLE.

The Stock Barometer signals tend to follow a 5, 8 and 13 and sometimes 21 day Fibonacci cycle that balance with 'normal' market cycles. Knowing where you are in the current market cycle is important in deciding how long you expect to maintain a position.

Potential Cycle Reversal Dates

2006 potential reversal dates: 1/16, 1/30, 2/25, 3/19, 4/8, 5/8, 5/19, 6/6(20), 7/24, 8/20, 8/29, 9/15, 10/11, 11/28. We publish these dates 2 months out.

We'll take a closer look at this 10/11 date this week - which I think is going to be a big week. With our indicators being extended, I don't think we'll see the continuation of the move higher - but this rally has been remarkable. And the job of the market is to fool the masses. So as soon as more capitulate looking for downside and finally adopt this move higher, then it will likely be a top. I think we're close.

My timing work is based on numerous cycles and has resulted in the above potential reversal dates. They're predictive and have nothing to do with the barometer cycle times. However, due to their accuracy in the past, I post the dates here.

2005 Potential reversal dates based on 'other' cycle work were 12/27, 1/25, 2/16, 3/4, 3/14, 3/29, 4/5, 4/19, 5/2, 6/3, 6/10, 7/13, 7/28, 8/12, 8/30-31, 9/22, 10/4, 11/15, 11/20, 12/16.

Stock Barometer Buy And Sell Signals

QQQQ or SPY Chart: A chart is provided in every bi-weekly report and shows the barometer Buy and Sell Signals (which are provided in my morning updates) as well as showing the next highlighted 'reversal' window. The numbers adjacent to the buy and sell signals are the number of days between signal (cycle time).

Here's one years of our end-of-day buy and sell signals for the Stock Barometer over the past year. They're marked on the QQQQ chart with red and blue lines (or red and blue arrows).

The following work is based on my price based spread/momentum indicators for the USD$, XAU, GLD and TLT. They are tuned to deliver signals in line with the Stock Barometer. Combined with up/down indicators and you have a powerful tool for pinpointing market reversals.

Gold (GLD:AMEX & INDEX:XAU.X)

I monitor Gold in the form of GLD and the XAU as well as the US Dollar Index as a general guide to the overall health of the US Economy and the markets, as well as to assist us in the entry of positions in our Gold Stock Service.

Bonds (Amex:TLT)

I include bonds in our studies and use Lehman's 20 year ETF, as the direction of bonds can have an inverse impact on the stock market. Normally, as bonds go down, stocks will go up and as bonds go up, stocks will go down.

Summary & Outlook

We remain in Sell Mode, looking for the market to move lower into 11/28 - setting up a 9 month cycle low and a nice year end rally.

Was 10/11 a top or a bottom? There are two camps (as there always are in the market) those who think that the market is going to rally into 11/28 and those who think the market is going to move lower into 11/28.

We've remained in Sell Mode, a bit longer than normal, waiting for our indicators to turn lower and set up this next sell signal. We're there, and we absolutely must get lower action this week, or we'll move into the other camp and position accordingly. However, as you can see, the indicators we follow, for the most part, are quite bearish - and we should at least get a consolidation.

Again, if you're new to the biweekly stock barometer, welcome. This article comes out every 2 weeks and gives a big picture view of the market and our recent activities. If you're interested in following our signals and learning more about our system, then I invite you to click here and subscribe to the daily service - since the market can turn on a dime and so to can our interpretation as the market gives its daily clues to the future. Or sign up for our free weekly newsletter, where we provide up to date articles from our various trading services. We're also going to be releasing a free trading video - so sign up today.

As always, if you have any questions or comments, feel free to email me here at jay@stockbarometer.com.

Regards,

Jay DeVincentis
Dynamic Trading

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