Expecting a Bounce

Underlying breadth wasn’t particularly strong yesterday, though scans didn’t turn up anything particularly negative that might warn us that we are at risk of a breakdown here. The wide ranging doji at the trend lines on both the NASDAQ and S&P indices is about as good a reversal signal as any other we have come across and we need to honor it (see QQQQ chart below). The signal is complimented by both oversold, but improving technical indicators and by the fact that options traders have reversed course from an overly bullish position to one that is overly bearish. Options traders are very good at calling reversal points in the market in that they are so often very wrong in the positions they take. When a majority of call options are being purchased like they were at the end of July and the first of August, we can just about be assured the market is overbought and ready to collapse. Likewise, when a majority of put options are being purchased, we know that these unlucky traders are becoming overly bearish and that a reversal to the upside is fairly imminent. Yesterday they were buying puts hand over fist. Allow for some volatility here. They may try and shake loose a few more shares before it reverses and suck in a few more unlucky put buyers, but we can just about be assured the market will bounce from very close to current levels. We don’t know how strong the bounce will be yet as there is just no way to determine this. It makes sense to start buying at these levels though and then make adjustments as necessary later on.