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Sentimental indicators are approaching bearish

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As my first commentary, I'll first revisit why I got quite bullish, especially in terms of the S&P, in a commentary I wrote 2/22. This was prior to my joining OptionInvestor.com which occurred only this week.

One of the most important studies that you can make of the market is to measure how bullish or bearish traders are. One of the best ways to see this is look at the daily CBOE volume numbers of puts to calls. I exclude the index numbers, to take out some of the influence of hedging activities and to get a more "pure" reading on how enthusiastic, or not, traders are for stocks.

Nothing much has changed since 100+ years ago when Charles Dow described how the market tends to go from extremes of bullishness to bearishness. Bullish sentiment extremes have tended to occur when CBOE daily equities call volume equals or approaches at least 2.4 times that of total daily equities put volume. Readings at this level or above suggests that traders are overly optimistic but may be unrealistic concerning the likelihood of a continued strong advance, as most market participants that are interested in buying in the near to intermediate-term, have already done so.

Bearish sentiment extremes have been reached when my call/put indicator gets down toward a 1 to 1 ratio, as occurred on 2/15 (circled) and shown in the chart below


After one day or more of such readings, within 1 - 5 trading sessions, the S&P index will often see good rallies. In a generally oversold market such as this one, the low readings are most reliable. (Some of the recent month's readings in the bearish extreme area did not have as great a predictive value as those in the bullish area.) When put together with other studies of the market internals, a significant value of this indicator is that it is a leading one. It gives you time to prepare a trading strategy.

A "confirming" technical tip off, also seen on the SPX chart, was the double bottom low formed over the following week after the call/put volume extreme. The combination of these two strong technical signals and others, provided a good reason for me to be quite bullish on 2/22. What about the current picture?

As can be seen from the chart above, as of last night's close, the call/put ratio is now climbing toward the extreme zone, of bullish sentiment. Moreover, recent SPX highs are into an area of significant resistance in the 1170-1175 zone, as evidenced by relative highs in this area in early-Dec. and early-Jan. It is not surprising that the market is down today.

I look for a continued pullback or drift sideways, such as for a week or more. Consolidation of prices can be expected before the S&P moves above the current triple top. Wait for this consolidation to end, then look to the buy side. Good support should be found in the 1130 area. The forth rally through a top area is usually leads to strong follow through. A move above 1175 suggests follow through to above 1200 at a minimum. Tough resistance will be found in the 1240-1250 area however.

The leadership provided by blue chip cyclical stocks is telling us that the current rally is in the early stages. Don't look for the tech stocks to get into gear for a while. Given the erosion of time premiums in volatile stocks not ready to mount sustained rallies, look instead to buy what is moving, after this anticipated pullback and consolidation runs its course. Being too early in a sector(s), using options as your trading vehicle, is a losing proposition. The same for being too early in index options. Patience should bring rewards here. The market is resisting going down here, but it doesn't mean it is ready to blast off either given the substantial move that has already occurred in this first stage.

Leigh Stevens

Activated on Adelphia

Today in the market monitor on OptionInvestor.com and in our bearish play list at premierinvestor.net, traders may be short/put shares of Adelphia Communications (NASDAQ:ADLAC). For the past two weeks, premierinvestor.net subscribers have been edging up their trigger point to short the stock and today's break of $23.99 triggered our entry point. Here's a look at the bar chart of Adelphia Communications (ADLAC) and some things I'm looking at that we will monitor going forward.

Adelphia Communications Chart - Daily Interval

We've been monitoring the levels of retracement for the past couple of weeks as ADLAC has marched higher day by day. On Friday, shares of ADLAC traded our 50% retracement level and for the first time since finding a bottom at $18.76, the stock has traded below a previous day's low for two-sessions in a row. This is a bit of DIVERGENCE from the past couple of weeks and may now mark a rally top. Volume spiked a bit last Thursday, but has since been tapering off, almost as if there is little interest in the stock at current price levels. I've overlaid a regression channel (2 standard deviations) that now becomes a downward channel a bearish trader may be looking to trade. I like the "crisscross" of mid-regression with 100% retracement at $18.76 to define a trading target at the $19-$20 level. We have noted in the past that the current vertical count from our point/figure chart is bearish to $4. The recent rally to 50% retracement also comes at the large volume spike found from January 16th when 46.5 million shares traded hands. I'm (Jeff Bailey) looking for any bulls that may have taken a position in the stock to use the recent rally as an opportunity to look for the door if they didn't like that move to $19 in early February.

Jeff Bailey
Senior Market Technician
Option Investor

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