On August 15, my Trader's Corner article dealt with the odd then-current behavior of the TRIN. One day in early August, writers on the live portion of the site, the Market Monitor, had been commenting on that odd recent behavior of the TRIN, an indicator that usually moves in opposition to price action.
Despite an early morning rollover in equities on the day in question, the TRIN had started out at a bullish 0.27 level and had maintained bullish numbers well below the 1.00 level some traders use to benchmark bullish versus bearish values. For those new to studying the TRIN, I'd suggest a review of that previous article, easily accessed through the archived Trader's Corner articles.
A brief review can be offered here, however. Since this is a contrarian indicator, a rise in the TRIN is usually considered bearish for equities and a drop, bullish. Calculating the TRIN sounds more complicated than it is. Dividing the advancing issues/declining issues ratio by the advancing volume/declining volume ratio is all that's needed. A result of 1.00 is often interpreted to mean that bullish and bearish forces are equally balanced. Volume patterns are backing up price patterns. Levels below 1.00 may indicate that more volume is pouring into advancing issues than into declining ones, so the result is bullish. Levels above 1.00 may indicate that more volume is pouring into declining issues than into advancing ones, so the result is viewed as bearish for equities. At least, that's the theory.
However, the TRIN had begun to evidence some strange behaviors, as that previous article detailed. The comments I was reading on the live portion of the site had led me to do some research using a market heat map. The heat map revealed which issues were rising. I then made some comparisons of daily volume with average daily volume in those issues. What I discovered was huge volume pouring into a few advancing issues. By late morning on that August day, CIT had already traded double its average daily volume and C had matched its average daily volume. Some of the most downtrodden and, in some cases, still risky financial-sector stocks were seeing the greatest volume, and their price increases, although small in dollars and cents, were distorting the TRIN. Some companies whose stock was considered almost worthless were drawing the strongest volume. Fannie Mae, Freddie Mac, Citigroup, AIG and Bank of America were five of the stocks drawing the biggest volume, but others have been included, too.
The financial press began calling these financials the "Phoenix stocks." I don't know who originally coined that phrase, but in his September 2009 monthly letter, William Hester of Hussman Funds, addressed the implications of the volume patterns in these Phoenix funds in an article titled "Without Phoenix Stocks, Volume Continues to Contract."
Those who have read my articles over the previous years know that I have always considered volume an important variable to watch. It's independent of price action while many of the indicators we watch--stochastics, MACD and others--are based on price action and so are not independent of price. Volume, on the other hand, can be light or heavy when price goes nowhere, can stalemate or climb when prices climb, or can decrease or increase when prices drop. Each combination either corroborates or questions the price action. For example, in a recent Wrap, I questioned the implications of a strong-volume trading day when price didn't advance much. If that strong volume couldn't effect a bigger rise than that, I concluded, then institutions were likely selling into the rise. The strong volume had proven institutional involvement and, if they'd all been buying, as had been the financial-TV-commentator conclusion, then why hadn't price risen strongly?
Hester's article caught my attention because I value volume patterns so strongly. My own conclusion in that August 15 article, based on my cursory examination of what was going to prompt the TRIN's strange behavior, was that the rally was perhaps not as broad-based as it seemed. The distorted churning of what is now known as the Phoenix stocks was rendering the TRIN less useful than it had been in the past. The under-the-market action wasn't as healthy as bull might like to see it.
Of course, markets went on to make further gains after that August 15 article and before the recent pullback. I hope that my point I'd made in that article that such price/volume divergences were not good market-timing tools was heeded. Still, the major precepts still apply. So, it's important to examine the information that might be offered to us from other sources. Hester's research went beyond my own, and he or his researchers compiled volume figures for four years that compared NYSE volume with and without Phoenix volume.
Hester's Comparison of Volume Figures with and without Phoenix Volume, September 2009 article:
Hester makes a point that I'd like to second. Without that extra volume provided by the churning of the new momentum stocks, the Phoenix stocks, there was no volume corroboration of the rally preceding the current pullback. Most times over the last four years, Hester points out, both volumes have moved in pretty much in lockstep with each other, but they diverged strongly this year, with volume pouring into the Phoenix stocks "that only recently were on the brink of collapse." His research indicates that recent weeks have produced days when AIG and C's volume measured 15 and 12 times, respectively, the average volume the stocks traded a year ago. Previously, volume in the Phoenix stocks made up about 5 percent of total NYSE volumes, Hester states, but over recent weeks has ranked at almost a fifth of total NYSE volume.
Is this proof of anything? Not yet, I wrote when I first roughed out this article more than a week ago. I'd still have to say "not yet," but knowing the lack of corroboration from volume patterns, I'm not surprised by the pullback we're getting. This lack of corroboration certainly offers a caution and a strong one, as I'd already concluded and stated in my article about the TRIN, before I read the Hester article. You know me by now if you've been reading my articles. I'm all about making what-if plans, and so I conclude again by urging you to make what-if plans, just in case. I'm more concerned about capital preservation than I am about growth, but I'm concerned about your capital preservation, too.
This week's Option 101 article discusses new research on collars. The collar is a strategy that I've discussed previously for those who prefer the buy-and-hold strategy for their long equity positions or who can't sell or lock in profits when certain levels are violate. Look at that article if you haven't considered collars or if tax or other considerations prevent you from setting thresholds at which you would sell long positions and lock in profits. After reviewing that article, discuss the pros and cons of such a strategy with your investment advisor or broker, or ask for other strategies that might protect your portfolio from inordinate losses. You can also find a couple of previous articles discussing other studies about collars in the February 13 and 27 Trader's Corner articles.