Tier 1

New Article Published on Seeking Alpha

2011-06-30T10:46:00.001-07:00

http://seekingalpha.com/article/277125-the-current-short-term-long-term-market-view

I've published a new article on seeking alpha regarding the short term and long term market outlook. Enjoy!

Stock Market Update for 04-17-2011

2011-04-16T22:33:00.000-07:00

Price momentum is down, but traders should wait a day or two before building a short position as the market has some short term rally potential. Our stop is a daily close above 1327.

http://www.youtube.com/watch?v=L56W-uyUHus

Stock Market Update 04-13-2011: Continued Sideways Action Ahead

2011-04-13T19:25:00.000-07:00

Market Update April 12, 2011

2011-04-12T20:10:00.000-07:00

April 11, 2011 - Video Post

2011-04-11T21:13:00.000-07:00

I go over some indicators as well as Demark sequential.

DeMark - Where to Set Your Stop

2011-02-03T14:09:00.000-08:00

Per Jason Pearl's interpretation of DeMark's methodology, the Dow Industrial Index sell signal would get stopped out with bar 13's range added to the top tick of bar 13. So a close much over 12,097.90 would stop out the sell signal. 1.618 times the range is 12,168.95, a more lenient stop, but obviously adding to your risk level. That being said it's so rare to have a monthly, weekly, and daily sell signal line up almost perfectly in all the major indexes...

Breakdown

2011-01-29T13:18:00.000-08:00

I've been detailing the bearish technical conditions in the market for the past few weeks now, and with Friday's strong close down, which qualified as a bearish price reversal (a close below .8 standard deviation from the 10 day moving average) in all the major indexes, I believe the correction I've been anticipating is now occurring. Judging by the extremes in sentiment and the long running divergences in breadth, the correction could be very significant.

In my last post I noted the Dow Non-Confirmation as well as the other riskier indexes breaking down ahead of the Dow Industrial average. Despite the strong move up Wednesday and Thursday, none of the secondary indexes managed confirm the Dow's high, in fact Friday the Transportation and the Nasdaq indexes managed to break the last swing low, with the Russell following close behind.

Chart 1: Dow Theory

So for now, with the sentiment extremes, the momentum extremes, the divergences in breath, and now mechanical signals telling us to sell the market, a very negative view is appropriate until at least some of these signals reverse.

Non-Confirmation Continues

2011-01-27T13:26:00.000-08:00

A continuing theme, the Dow continues to traverse the psychological important 12,000 round number. This has seemingly garnered a lot of excitement; there is no shortage in supply of wildly bullish guests on CNBC ready to proclaiming the market will continue to move strait up. Again proving the Milgram experiment valid, the masses seem to be nodding blindly to this community of "professionals" despite them missing every major turn in the last 10 years. Meanwhile, I've been noting the deteriorating internals, the extreme sentiment, the overbought momentum, and now the other indexes seemingly topping out, thus the Dow Theory Non-Confirmation continues...

Chart 1: DJI, Transports, Nasdaq, Russell 2000

The Nasdaq appears most willing to break to new highs, though with today late day reversals in Microsoft and Amazon, I'm not sure this will happen. Meanwhile the transportation index and Russell 2000 still appear to be correcting from their first thrust down, and are running into Fibonacci resistance.

Dow Non-Confirmation Continues, But Indexes at Fibonacci Resistance

2011-01-26T12:30:00.000-08:00

The Dow continues to inch higher. The other indexes are much stronger today, however, as we can see they are clearly not at new highs and at Fibonacci resistance. The Dow transportation index continues to lag, and create a Dow Theory non-confirmation.

Dow Theory Meets DeMark

2011-01-25T11:57:00.000-08:00

In my last few posts I've been noting that all the major indexes have completed TD-Sequential sell signals, minus the Dow Jones Industrial Index. As of yesterday's close however, the index has met the requirements for a sell signal under Tom DeMark's Sequential indicator. Furthermore there is an interesting Dow Theory non-confirmation forming between the Industrial index and the Transportation index.

Chart 1: $DJI with DeMark Sequential

The setup looks remarkably similar to the setup back in late April before the flash crash, with sentiment extremes, overbought diverging momentum, and a completed TD-Sequential sell signal. Another interesting development is that the higher beta indexes appear to be falling ahead of the Dow, creating a Dow theory non-confirmation.

Chart 2: Dow Theory Non-Confirmation, Dow vs Transports vs Nasdaq vs Russell

We can see here by this side by side comparison, that while the Dow continues to chug higher, the higher beta and wider breadth indexes appear to be disagreeing for now. While these can always reverse, it's another piece of technical evidence that must be added to the already quite full bearish side of the ledger.

DeMark Marks the Top?

2011-01-20T22:32:00.000-08:00

Since the SPX generated a TD-Sequential sell signal on the January 14th, the high thus far was set the very next trading day. Everything is in place for a reversal: sentiment extremes, diverging breadth, and overbought momentum. By some measures the market is the most overbought in decades. For example, the market has not closed below the 10 day moving average in 34 trading days (closing slightly below it today), something that has not happened in over 80 years according to sentimentrader.com.

Chart 1: SPX with Indicators

I'm just waiting for a close below .8 standard deviation from the 10 day moving average, a sign that price action has changed direction. The Russel 2000 and the Nasdaq have already closed below this line, while the Dow and S&P are still holding out. While candle patterns tend to be wrong often, they are also typically the first sign of a turn price action. They become even more predictive when all the other indicators are lined up, as they are now. Fisher transformed momentum is overbought, while stochastics look like they are starting to turn down. Coupled with all the other indicators I've been outlining on the blog (the put call ratio, McClellan, VIX, sentiment surveys, etc) and the result is a bearish mosaic.

DeMark Indicators Turn Bearish

2011-01-17T16:10:00.000-08:00

Tom DeMark is one of the many interesting personalities I've come across during my studies of the market and market indicators. Mr. DeMark literally drew his own charts by hand while developing his own methodologies. He's always worked for large institutions that cannot trade in and out of positions easily, so finding points of exhaustion to go against the trend are absolutely paramount in entering and exited positions. His indicators really help in selling into strength and buying into weakness. His most well known indicator (though not known at all to the retail public, something I personally like) is TD-Sequential. Looking at a daily chart of the S&P E-mini, we can see that completed setups do not occur often, and completed signals even less, but signals in the ES have been very accurate when they do materialize.Which brings us to...

Chart 1: S&P E-mini with DeMark Sequential

There have been 4 signals in the last year. The first signal which I've label A, occurred literally at the top tick in the e-mini before the flash crash, a nice selling opportunity. The next signal, B, occurred at the bottom of the summer weakness and was not reversed until C, which would have netted you 200 S&P points. Not bad. Signal C did not produce much weakness, but now we have another sell signal, D, occurring in conjunction with a host of other bearish signals. Label E for example, marks the highest reading in momentum in years. Add in the put call ratio, extremes in sentiment surveys, diverging breadth etc. In my opinion the signal shouldn't be ignored.

Market Breadth Update 1-10-11

2011-01-10T20:21:00.000-08:00

McClellan Oscillator and Summation Index continues to diverge, continuing to signal a non-confirmation to the current up trend.

Chart 1:

Percentage of Stocks above the 40 DMA continues to possibly diverge as well. At any rate, regardless it is not at a area where I would be looking to get long.

Chart 2:

Taking a look at the absolute breadth index, the indicator continues to suggest that we are nearer a peak than a point where going long is the smart trade. The indicator is the absolute difference between advances and declines then charted as the percentage increase or decrease from the previous day’s value. Tops tend to show low numbers as fewer and fewer issues participate and hope dissipates.

Chart 3:

Many factors are currently lining up in favor a tradeable correction, and at minimum breadth argues that this is at the very least not a smart place to try and get long the market.

Current Market Conditions

2011-01-10T14:36:00.000-08:00

Unfortunately, there is little to add to recent commentary. The market looks overbought and ready for a trade-able correction, possibly the start of something greater based on longer term indicators such as cash levels at mutual funds, dividend yields, Shiller PE, etc.

While ideally I would like to see the McClellan higher, indicating a more overbought market internally thus more susceptible to a correction, it may be showing a bearish divergence. However I certainly have mixed feelings on the implications of the McClellan's recent behavior, as it is in the middle of the range, and it meaning arguable in either direction near term. Indicators of simple momentum seem to be in place for a a trade-able correction, especially with confirming signals from the put call ratio. So most pieces seem to be in place, and I just continue to wait for price action to produce a sell signal.

Chart 1: SPX with Indicators

One Out of Seven People in the US Require Food Stamps

2011-01-07T13:12:00.000-08:00

http://www.bloomberg.com/news/2011-01-07/food-stamps-used-by-record-43-2-million-in-october-usda-reports.html

Out of the 312 million people living in the United States, over 43 million of them now require food stamps, or one in seven. This is an all time record as well as trend of new record highs that has been continually exceeded for 23 months strait, according to Bloomberg news. Clearly, the recession is over.

Market Sentiment - January 2011

2011-01-06T23:07:00.000-08:00

The bullishness seems to be really spreading to every corner of the market. Several of the indicators of market sentiment have been rising to levels that generally correspond to market corrections. Some have in fact risen to multi-year highs, and have surpassed the levels recorded in 2007 during the all time high.While these measures can always get even more extreme, they are an important potential red flag.

Chart 1: Investor's Intelligence - Percent Bulls

Gauging sentiment is not an exact science, but I think this chart is pretty clear, of the advisers and newsletter writers polled, the majority of them are bullish, recently hitting a high of almost 60%. This is the highest reading going all the way back to the 2007 all time highs. Put into context, this reading is even more extreme than during 2007 because back then economy was humming along. Now however, we have extreme optimism in the face of high employment, crushing deficits, a municipal bond market crashing, European debt crisis etc etc.

Chart 2: Investor's Intelligence - Percent Bears

While bulls have been surging, the ranks of those willing to stick their necks out and go against the crowd are slowly being depleted. Other than a few "perma-bears"; Rosenberg, Prechter, etc, it seems no one thinks 2011 will be anything other than spectacular for stocks. To quote Bob Farrell, "When all the experts and forecasts agree -- something else is going to happen."

Chart 3: Bull Bear Spread

While this may or may not be the start of something more significant than a correction, it would be wise to reduce exposure to stocks or at least hedge exposure. Previously when the bull - bear spread has reached these levels, corrections have started, including the 2007 reversal off the all time highs.

Chart 4: AAII Percent Bulls

It seems that advisers and newsletter authors are not the only ones getting bullish. Individual investors, polled by the American Association of Individual Advisers, are also getting very bullish. In fact, individual investors are more bullish than they've been in years, surpassing the 2007 all time highs.

Options speculators seem to be jumping on board as well. I'm curious where the put call ratio will end up. There have now been 3 signals generated by the 5 day moving average, and it looks like there might be another signal generated by the 10 day moving average.

Chart 5: The Put Call Ratio - 5 day moving average

The current signal is very likely to be even more extreme than the two previous signals because 4 out of the last 5 days the put call ratio has closed below 1 standard deviation from the mean. Tomorrow, when the fifth day drops off, the 5 day moving average is going to move lower, much lower if the close tomorrow is again on the call side extreme.

Chart 6: VIX vs SPY

The VIX also is reflecting the rise in optimism; the VIX basically measures the cost of insuring a portfolio, once investors get complacent is ironically is almost exactly when the market is about to decline. We can see from the chart above that the current level in the VIX has recently corresponded with reversals. I would also note that the last few days the VIX has possibly started to turn upward.

I remember very clearly the bottom in March 2009; watching CNBC as stocks started to rise, every single guest said that the rise off the lows was a bear market rally, that could be traded, but ultimately had to be sold, as the market was doomed to sink even lower. I'll never forget how intense the bearishness was among the herd. Today we have the exact opposite picture. Watching CNBC as stocks hover at 2 year highs, every single guest is saying that 2011 will be great, and any correction must be bought for the market is only heading higher. All the major indicators of sentiment continue to hover near extremes while the measures of strength and breadth lag price, conditions that have accompanied almost every top.

The Baltic Dry Index Decline Accelerates

2011-01-06T08:55:00.000-08:00

The Baltic Dry Index, a real time economic indicator of world trade continues to disagree with the myriad of Government polished data. I've noted for a over a year now how the BDI has been diverging from the stock market, and has in fact not even come close to the 60 something percent retracement that the market has been able to muster up. Most of the shipping stocks have also been lagging the general market as well in terms of percentage gains and retracement.

Chart 1: Baltic Dry Index - 6 Months

We can see that the Baltic Dry Index has not only been declining, but in fact accelerating, breaking the lower boundary of trend channel.

Chart 2: Baltic Dry Index - 3 Years

Besides accelerating to the down side, we can see that the BDI is back to 2009 levels, when the economy was basically falling apart. While the Baltic Dry Index obviously has not been a fantastic short term market indicator, one has to wonder, why the wild divergence and accelerating downtrend if the economy is truly picking up steam? It did produce a divergence in early 2009, indicating that the economy was indeed bottoming before the stock market realized it, one should at least be aware that the BDI may now be producing an opposite signal.

A Longer Term Look

2011-01-04T11:55:00.000-08:00

While the corporate lackeys on CNBC continue to try and bilk the remaining retail investors, and convince the last few mom and pops out there saving for retirement that the market is cheap, and of good value, a look at some long term indicators of value tells a different story. Analysts, corporate shills, economists, Cramer, the major investment research houses, and the regular gurus making the rounds on the media outlets all agree; 2011 will be a great year. As Bob Farrell noted in his rules, "When all the experts and forecasts agree -- something else is going to happen."

Chart 1: The Shiller PE Ratio (courtesy of www.multpl.com)

First, the long term average is about 16. So assuming paying 16 dollars for 1 dollar of earnings is historically a fair value, the market at 23 is overpriced by 40%. But since earnings typically fall at the same time price, 40% is most likely a conservative estimate. Second, notice that in the long term, prices oscillate up, then down, then up etc etc. Bob Farrell's rule 2: "Excesses in one direction will lead to an opposite excess in the other direction." Not only are stocks expensive still, but prices are still mean reverting from the most historically overbought period ever. It stands to reason that not only will the market mean revert, but have an equal and opposite reaction. Meaning, I doubt stocks will simply "correct" but will instead trek lower for years, way beyond what almost anyone thinks possible.

Chart 2: S&P Dividend Yield (courtesy of www.multpl.com)

Looking at the dividend yield on the S&P, we get a similar view. The yield oscillates as investors either demand safety or flee safety for risk. Investors today are historically very complacent, and even the huge crash in 2008 didn't bring the yield back to the historical mean. Until these two long term measures come to at minimum, back to their long term means, I think its very presumptuous of analysts, gurus, etc to be proclaiming the market is "cheap" or represents good value. If history rhymes; a bullish consensus plus long term indicators of value historically high, the next several years will in fact be rather tumultuous, and not the cake walk that most are now calling for.

Charts To Start 2011, Part 2

2011-01-03T12:25:00.000-08:00

In Part 1 I outlined several predictive indicators that have been raising red flags. While it is not unusual to see a divergence or an extreme here or there if looking across the broad spectrum of indicators, when they start to cluster, that's when high probability trades emerge. Here are some other charts of interest.

Chart 1: S&P E-mini and Momentum

Momentum is literally the most overbought it has been going back years. I prefer simple momentum indicator with the fisher transformation applied. Signals are generated when momentum gets overbought then crosses back below the overbought signal line. While no signal has been generated yet, the fact that the E-mini is the most overbought according to this measure in years is a red flag, and adds weight to the bearish case, especially since this is occurring in conjunction with so many other reversal signs. (You can read more about fisher transformation here: http://www.tradingsystemlab.com/files/Using%20The%20Fisher%20Transform.pdf)

Another phenomenon is the number of new highs, but also new lows occurring at the same time. This manifested some months in the form of several Hindenburg omens. The media focused on them intensely, but the market since rallied to new multi-year highs. I also find it interesting that while there was a lot of media attention on the Hindenburg omens some months ago, recently there has been more Hindenburg omens triggered with almost no media attention whatsoever. This leads me to believe that the previous signals failed because there were too many bears prevalent in the market, currently however, this is not an issue.

Chart 2: High/Low Logic Index

The plurality of highs and lows is not only spiking but trending higher. The last few spikes have occurred with almost no reaction. I would say that this implies that something is brewing beneath the surface of the market, and the most recent rise if very vulnerable to a correction.

While on the subject of breadth.
Chart 3: Percentage of stocks above their 40 day moving average.

We can see that the percentage of stocks above the 40 day moving average ebs and flows with the tide of the market. This presents something of a similar picture to the McClellan oscillator; either stocks have a ways to run higher before getting overbought, or this is a huge bearish divergence. What makes me lean towards the later is market sentiment and the put call ratio. The put call ratio is showing that speculators are positioned for a huge rally (with leverage). It is just so rare to see any kind of sustained move when the put call ratio is so stretched. So if sentiment indicators are already at an extreme, and investors are fully invested, the more probable interpretation of this chart is a bearish divergence.

I'll close with Bob Farrell's rule number 7: Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. Momentum and sentiment are running at multi-year highs, however almost every measure of breadth is showing a deteriorating internal picture. While there is no confirmed negative price action jump onto, the next profitable trade is not to chase here, but to go against the crowd and sell when the next signal emerges.

The Fed Has Succeeded

2010-12-29T18:46:00.000-08:00

The Investment Company Institute reported this week that for the first time in almost a year, there has finally been an inflow in domestic equity funds. All the major sentiment surveys are at extremes, and this new data point confirms that The Fed has succeeded in finally getting the retail investor to put his last dollar back into the market, allowing insiders to sell their remaining stakes at lofty prices.Insiders have been selling almost every single week at a clip of several hundred to one. Meanwhile no major investment outlet has a sell on the stock market for 2011. How can it be that the people who run these companies, with about as much inside information as you can get, are selling hand over fist, yet almost all analysts have been upgrading their market outlook? This new data point does not pass the smell test, and only confirms the myriad of other red flag signals popping up all over the place.

Chart 1: ICI Fund Flow Data

The Charts You Need to See Before 2011, Part 1

2010-12-28T09:09:00.000-08:00

I hope everyone is enjoying the holiday season, a new year is upon us, and as we approach 2011, I thought I would just post up to date charts of some indicators that I feel are worth looking at.

Chart 1: VIX vs SPY

I wrote about the VIX recently when it started to flirt with levels that typically mean 1) investors are complacent regarding risk 2) declines of various magnitudes have followed. I've outlined here some instances in the last several years when the VIX has gotten to similar levels and the reaction in the stock market. While we are talking about the VIX, I might as well update the other valuable option indicator; the put call ratio.

Chart 2: Put Call Ratio vs SPX

I've calculated and added a 1 and 1.5 standard deviations as well as a 10 day moving average. The nice thing about the put call ratio (compared to the VIX) is that it can give you buy signals as well as sell signals, such as the buy signal in June, or some 200 S&P points ago. Now however, like the VIX, it is signaling that investors are overly optimistic and complacent. I've highlighted some previous examples of when conditions were similar and an almost immediate sell-offs occurred.

While discussing the put call ratio it makes sense to also review some of the other sentiment indicators, namely the Investor Intelligence and American Association of Individual Investors.

Chart 3: Investors Intelligence

The bull bear spread is reaching generally bearish levels. I've highlighted some of the other recent instances when the spread was this large between bulls and bears, all of which preceded corrections of various degrees, included the top in 2007. Advisers, who blew monumental opportunities to sell the 2007 and buy the 2009 bottom are back at it again. After a record run in stocks, now they are bullish. Individuals seem to agree, see the below chart.

Chart 4: American Association of Individual Investors

Another look at the current McClellan Oscillator.

Chart 5: McClellan Oscillator vs SPX

I prefer to sell the market when the McClellan is much higher, however sometimes I have seen divergences, which usually occurs right before intense, fast declines, such as in "Flash Crass." You can see the divergence develop in the chart above. The McClellan got very overbought and then a huge divergence developed, seemingly with no market reaction, then the market dropped suddenly in May. More recently, starting in August, the McClellan has possibly been diverging for months. While one can make the argument that the market will continue to rise until the McClellan is overbought, which normally I would agree with, but the summation index also shows both a large long term divergence, and a short term small divergence between this and the previous most recent peak. This makes me lean towards the bearish interpretation.

Part II coming in a day or so.

Market Breadth Continues to be a Problem

2010-12-23T23:00:00.000-08:00

The drones on CNBC continue to talk about breadth seemingly without any understanding of what they are talking about. Bob Pisani continues to impress upon his viewers his wisdom with such gold nuggets such as, "Some traders think breadth is bad, others don't (I paraphrase here but you get the idea)." The reason breadth is important is breadth can tell you how far along a trend is. During market bottoms most stocks are participating as selling climaxes. Tops in the stock market on the other hand tend to be much more rounded; fewer and fewer issues participate as hope dissipates and buying power is exhausted. So when the market average starts move higher with fewer stocks participating, that can be an indication of an upcoming correction, even top.

I've posted several charts here of the McClellan Oscillator and Summation Index, some of my favorite studies to look at, and very predictive in my opinion. The divergences that I've pointed out continue, and while the indicators could always turn and reconfirm the uptrend, that just seems beyond what is possible in my experience.
Chart 1: McClellan Studies

The McClellan studies continue to show that momentum in breadth actually peaked months ago, and there are multiple divergence at both large and small degrees. Another way to visualize the breadth of the market is too look at the absolute breadth index, which is the percent change in the absolute difference between advancing and declining issues.
Chart 2: Absolute Breadth Index vs SPY

As I mentioned, lulls in breadth tend to happen near corrections. I've added bands that represent 2 standard deviations from the 200 day mean. We can see from the chart that every time breadth dropped below 2 standard deviations from the mean, short term tops followed almost immediately. Not only has the indicator dropped to that level, and has fallen further than previous drops, but also occurred concurrently with a host of other technical indicators indicating a correction is near.

A Merry Christmas or a Lump of Coal?

2010-12-20T13:46:00.000-08:00

All major sentiment surveys, the S&P dividend yield, the Shiller PE ratio, and cash levels at mutual funds are telling us the same thing; investors are the most optimistic they've been in years. In my experience the next long term move is never obvious to the investing public. When the herd get's bullish, I want to start thinking bearish (and vice versa).

Two of my favorite studies to look at are the put call ratio, and the McClellan oscillator/summation index are showing bearish conditions, similar to the May flash crash.

Chart 1: Put Call Ratio

The put call ratio's 10 DMA has crossed over the 1 standard deviation line (the setup) and may have crossed back (the trigger). I say "may" because depending on the close over the next day or two, if they are extreme on the call side, it could temporarily drag the moving average back into the setup area. Regardless, the message is the same, speculators are betting heavily on the upside after the run has already taken places, and longs are not hedged and unconcerned with a decline.

Chart 2: McClellan Oscillator and Summation Index

Usually I like to sell the market when the 5 day moving average is much higher and turning back down through the 1 standard deviation line. However, a few times I have seen moves continue despite a rolling over McClellan, but when the market finally does change direction, especially when sentiment is peaking, the resulting move is generally fiercer than usual. Note in the above chart that not only is there a rolling divergence, much like the one that occurred right before the "Flash Crash" but this divergence is actually even larger and longer running. Not that this guarantees large downward move, but it is interesting to see this phenomenon again with the same reading on the put call ratio.

A new addition to the list of sentiment indicators reaching extremes is the VIX, which recently fell to 15. This confirms the put call ratio's signal and furthermore upgrades the significance and importance of the signal.

Chart 3: VIX

We can see from the chart here that the VIX is at extremes that it hits maybe only once or twice a year. The VIX is essentially what investors are willing to pay in terms of insurance on stocks. Clearly, investors are not worried, which is ironic because lulls in volatility precede spikes in volatility, in lay terms, the time to buy house insurance is BEFORE your house burns down, not after.

The Setup Looks Bearish

2010-12-15T10:45:00.000-08:00

Besides the put call ratio looking ever more bearish, the McClellan oscillator and summation index continue to show huge divergences. When I noted this a week ago, the NYSE and Dow were not following the S&P and Nasdaq to new highs, though since the have followed to marginal new highs. That said, the divergences are so large my feeling is they must mean something, especially with sentiment at the requisite level where I would begin to expect a trend reversal.

Chart 1: A quick glance and the NYSE

While the closes are still above .8 standard deviations above the 10 day mean (bullish price action) we can see from the RSI that there is a bearish divergence in momentum. Volume continues to be an issue, and has receded, especially during last two weeks.

The McClellan oscillator and summation index are some of my favorite technical studies to look at. It surprises me to see how little utilized they are considering its predictiveness, especially in combination with just a few other tools. I honestly believe one could trade successfully by looking at this study alone. That said, lets see what it is telling us now.
Chart 2:

Two areas of concern here. One, McClellan is showing us not only a divergence in a daily degree (showing I divergence between this peak and the peak in November), but, two, also a large divergence between this rise and the rise in August. This could indicate that the entire sideways gyrations for the last several months are corrective in nature, not a break out, and the impending correction could be larger than most expect.

When most people discover oscillators from a book, website or whatever, they note that divergences almost always appear at turns. Well that's because books only show examples of of turns. In practice/reality people discover that divergences appear all the time, then can disappear as prices continue on there way. I would say a high percentage of divergences are meaningless (especially in momentum). The correct way to use them is in concert. When divergences in price, momentum, and breadth occur together, and at a sentiment extreme, then however you have a very high probability setup, and that what trading is all about. Folding the low probability setups, betting on the high ones.

So lets review:
The closes of the major indexes continue to eek out gains. Sentiment by almost any measure is very high. Some measures show sentiment to be at multi-year highs and the put call ratio is generating a sell signal. Momentum is lagging and showing divergences. Breadth is lagging mightily and showing large divergences in both weekly and monthly peaks. Prices may continue higher, but I would not bet on it.

Market Sentiment, continued...

2010-12-14T06:35:00.000-08:00

The one thing you do not want to see if you are bullish on stocks is a strong consensus that stocks will go up. The crowd is usually wrong, and the bigger the crowd, the more wrong they get. Right now the crowd is getting pretty big. The way I like to explain it to people is this. What is a trend in a financial market? In its simplest terms its people changing their minds from one direction to another. So lets say that the entire stock market is only made up of 10 people. By the time the 10th person buys, prices literally cannot go any higher. There is simply no one to bid prices higher. While this example obviously simplifies the task of determining how many people are committed to one side of the other, there are various measures which one can use to gauge how far along the trend is.

Chart 1: Investors Intelligence Survey
Courtsey of Market Harmonics

Percent bulls is certainly at the highs of the range, and percentage of bearish respondents is quickly drawing near the danger level as well. This is not what the sentiment backdrop would look like if this was the start of a new rally leg, as most are claiming, but in fact the opposite. The American Association of Individual Investors is showing a nearly identical reading, with 53% responding bullish to last weeks poll, 14 points above the historical average.

Also interesting is the last week commitment of traders report for the S&P e-mini. I like looking at the commitment of traders report because one can easily make a direct comparison between large trader and small speculators. Small speculators tend get it wrong, especially at turns, while large traders tend to be positioned correctly.
Chart 2:

What's interesting here is while most of the sentiment surveys show a bullish consensus, large professional traders have actually accumulated a large net short position in the S&P e-mini. In fact, it's the largest net short position that they have held in over two years, and right before the market took a nose dive in late 2008.