Wednesday, May 31, 2006
The VIX, which we have been discussing over the past couple of weeks produced more very interesting and useful information yesterday. After giving back most of its recent gains over the past week, indicating that investor complacency was once again returning, yesterday's sharp market reversal caused the volatility index to make its sharpest reversal ever. The price on the index jumped an incredible 23% in just one day. Consider the fact that this index measures investor fear, we can ascertain that fear levels jumped through the roof yesterday as stock prices gave up most of their recent gains. Moreover, the bearish posture that traders took on yesterday was also reflected in the QQQQ put/call ratio. Options traders, the group that is so often wrong at market turns, bet 4-1 in favor of more downside. Considering the fact that the QQQQ found strong support last Wednesday, add in an overly bearish crowd that is running scared and you have the makings of a bear trap. Our scans today revealed a great deal of very nice short setups and we can certainly empathize with the temptation to short this market. Panning back to the weekly views though we find only very oversold stocks that are at or near support levels. We saw the same view last October right before the market reversed strongly. We will not make a prediction at this point for a market rally like the one that ensued from October's lows, but we will say that shorting this market is very risky. If prices go below last Wednesday's lows and volume picks up on the slide, then we will concede that the crowd got it right this time and that the market is moving from a minor to a much more significant correction. Right here, right now, history tells us that it is unwise to place that bet.