The Futures / Inter Market Report

Trading the World’s Markets                            

January 18, 2008

                                            
Matthew Caruso, CMT                                  
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Stock market at MAJOR buying opportunity

            The stock market has sold off precipitously in the past few weeks totaling approximately 16% from its historic highs only a few months ago (this was forecasted here 2 months ago). This week I am the bearer of good news; the stock market is approaching a major low and represents a major buying opportunity. The market has sold off excessively and is due for a major rally and I will explain further why I believe this is likely. It is my opinion that there is greater risk now in shorting the market than buying it. 

Anyone who wants to know what the calls were in the past for this market letter and what methods I typically employ in market analysis, can look into the following past letters. I have written about the stock market here on 3 previous occasions. July 25^th (http://tradesystemguru.com/content/view/75/58/) after a 5% correction I was very bullish. On November 16 (http://tradesystemguru.com/content/view/118/58/) after we experienced the first leg down in this correction I wrote that the market was oversold short term, due for a bounce, and that it would eventually fall 15% to approximately 1350. After a rally higher, on December 28 I became bearish once again and called for the second leg down in the 15% correction (http://tradesystemguru.com/content/view/133/58/).   

The S&P 500 has fallen past the 1350 level that was forecasted back in November and is oversold on several levels. One of the main tools used this week in identifying this bottom is the new synthetic vix index invented by Larry Williams which he has written an excellent article about in the December issue of Active Trader magazine. I will not go into great detail about the construction of this indicator – Williams does a great job doing that in Active Trader. The indicator was constructed to mimic the volatility index of the S&P 500. High readings in this indicator are typical of market bottoms on which ever time frame it is used. In order to adjust for changing market dynamics I have used a Bollinger band to identify significant readings, readings above the 40 day Bollinger band are used to identify “significant” readings. These significant readings that occurred from 2006 to now are highlighted in figure 1.

A picture is often worth a thousand words. As you can see, we are at an important level in the synthetic vix. To help further see the importance of this signal, let’s take a look at other market periods such as 2000-2004 in figure 2 and 1996-2000 in figure 3. This indicator has called every major market bottom of the past 12 years and has remained neutral the rest of the time. This is absolutely fantastic. 

Figure 2 chart by genesisft.com

Figure 3 chart by genesisft.com

Figure 4 chart by genesisft.com 

That’s not all we are looking at this week, however. If you’ve been reading this letter for any amount of time you would know that I never like to look at just 1 indicator to form an opinion but rather use a consensus of indicators. In figure 4, I have the Larry Williams’ sentiment index (learn more on this at ireallytrade.com) and the MACD displayed in the lower panels of the chart. The typical user of the MACD would notice that the MACD is negative and perhaps interpret this as a bearish omen for the market. However, what is important to look at is excessive downward movement of the MACD which can be seen in the blue histogram. Again to help find significant levels we used a 40 period Bollinger band. As you can see this week we have crossed below that lower band showing excessive downward pressure. As well, what is even more bullish is that the fact that only 5% of advisors remain bullish as indicated by LW sentiment index in the bottom pane. This excessive reading in bearish sentiment as well as the extreme reading in the MACD is typical of the market bottom. All other times that the market had this setup are indicated on the chart by the orange zones. This setup along with the vix readings discussed earlier lead me to be a major bull on this market going forward. It is my opinion that there is greater risk now in shorting the market than buying it. 

Figure 4 chart by genesisft.com

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