Wednesday, May 02, 2007

The Preponderance of Evidence

A criminal conviction requires the assessment of guilt beyond all reasonable doubt. Success in the financial markets is more like civil law: all that's required is a preponderance of evidence.

Since the March bottom, the market has definitely provided such a preponderance. However, if the sentiment polls are correct, many investors have had a difficult time believing the signals. The urge to try and outsmart the market is very powerful. However, following the market -- rather than anticipating it -- works with astonishing consistency.

Below is a timeline of key "follow the ball" moments over the past two months. Each of these signals came directly from the market itself.




Feb 27 - Mar 3 -- A 9% Shanghai plunge takes the US markets down 7% in a week. Bearish investor sentiment skyrockets, and the VIX doubles. Despite just a 7% tumble, investors are unusually scared.

Mar 15 -- In the grips of selloff blues, the Ides of March sees a huge intraday reversal at the NASDAQ 200-day. It surprises amateurs and pros alike, and carries all of the hallmarks of a double-bottom (it was; chart below).

Mar 16 -- VIX confirms its peak and then falls, triggering a VIX Buy signal.

Mar 21 -- Marty Zweig's famous Nine-to-One Up Day. Every bull market in history has been launched by one of these: Up Volume outpaces Down Volume by a ratio of 9-to-1.

Mar 22-24 -- A 5-10-20 Buy signal is triggered on all of the major indexes.

Mar 24 -- The 2 year/10-year yield curve inversion heals, and copper -- the metal with a Ph.D. in economics -- has now rallied 28% off the Feb low. Regardless, the recession drumbeat grows louder on subprime woes.

Mar 26 -- Gory details of the subprime mortgage fiasco spark a huge market sell-off -- for 15 minutes. The Composite bounces off the 50-day and closes in the green, while 24 IBD100 stocks print record highs. Lots of pundits are stunned...though it may have been due to the surprise death of Anna Nicole.

Mar 29 - Apr 1 -- The Stealth Rally: as pundits obsess about the looming weak earnings season, the Composite bounces off 5-month support for 3 straight days while market internals stay positive. The IBD100 quietly begins a long rally on huge breadth and record highs.

Apr 2 -- The market internals -- and the IBD100 -- prove correct, and the NASDAQ breaks out above its 50-day. It hasn't been back since.

Apr 4 -- The TOF Ratio triggers a Buy signal.

Apr 10 -- NYSE hits new all-time high.

Apr 16 -- The Day of Global All-time Highs -- Nine global markets print all-time highs, and the NASDAQ, Dow and SPX all gap-n-run. This marks the second in a series of bullish ascending islands. SPX and hits new 6 1/2 year high. MID hits new all-time high.

Apr 18 -- The Dow hits new all-time high.

Apr 19 -- US markets are unfazed by another heavy Chinese selloff. Surprisingly strong Q1 earnings have become a primary investor focus.

Apr 20 -- Dow Theory confirms rally on trifecta of new highs. Meanwhile, OEX and NASDAQ break above key Fibonacci levels.

Apr 22 -- NASDAQ, NDX and SML hit new 6-year high.

Apr 24 -- The beleaguered SOX breaks above 5-month resistance and posts 52-week high.

Apr 25 -- Dow hits 13,000 as New Highs outpace New Lows an astonishing 602-69.

The story continues...

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Bill Luby said...

A post for the archives, dk.

I was particularly impressed when the ISEE hit an all-time low on March 8th -- with various ISEE moving averages soon to follow.

Also in the put to call realm, the $CPCE activity on March 13th was quite dramatic, as were the generally high readings in related SMAs that week.

dk said...

Hey Bill...thanks for the comments. I was encouraged by both your Mar 28 and Apr 23 posts, as they cooroborated what I was seeing in other indicators. Prior to you, I've never used ISEE.

My two favorite buy/sell indicators are the TOF Ratio and the IBD100. In the 8+ years I've used the IBD100, it's never failed me as a sell indicator. If it's going to be reliable, I guess I'd prefer it to be so on the sell side - lol.

Thanks again.

damien said...

Would it be possible to have more infos (links,...) to your methodology using the TOF Ratio and the IBD100 as sell signals?

Been reading your blogg for a couple of weeks now and appreciate the fact that you are neither a perma bull or perma bear and modelstly listen to what the market is trying to tell you (and me by the way but unfortunately still haven't leaned the language...)

Best regards

dk said...

Thanks for the question Damien.

The TOF Ratio was developed years ago by a message board poster, The Old Fool (aka TOF). TOF now posts daily over at the ^IXIC board at His ratio is the NASDAQ divided by the CPC ($COMPQ:$CPC), and it triggers a buy or sell when the 21-day crosses above or below the 50-day.

The IBD100 is published weekly for subscribers by Investors Business Daily. It's a computer generated list of 100 companies sporting the very best fundamentals, under accumulation by the market and trading near their highs. I download the list each week, make a tracking portfolio and then gather data from it.

What I've found is that these 100 are the true canaries in a coalmine. When the market's ready to turn south, investors sell these very hard and fast. When this happens, take cover because the ensuing decline is for real. In late February, the IBD100 fell in line with the market, a sign that the selloff wasn't the real deal.

Anyway, hope this helps, and thanks for the question.

Bill Luby said...

Just to clarify the TOF ratio ($COMPQ:$CPC), those are 21 and 50 day EMAs, not SMAs.

At one point, dk, I thought you were using EMAs and TOF was using SMAs, but it looks like you are both standardized on EMAs at the moment, unless I am mistaken.

Safe traveling.


dk said...

Hi Bill...good observation. To clarify, the TOF Ratio uses EMA. You are also correct that I had been using SMA since the Oct 2005 IT bottom through the May 2006 top, etc. SMA is slower and occasionally creates a more reliable crossover. However, to keep the public discussion consistent, I've switched back to posting EMA, while keeping the two versions next to each other in my list.

Both the CPCE and CPCI produce interesting insights as divisors as well. Throw in breadth indicators like the BPCOMPQ as numerators and...well, that's worth a whole new post! Hmmm....

jaye said...

Good blog, BK.