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Friday, May 15, 2009

The VIX , CPC and Trader Sentiment

Notice the Rate of Change (ROC) indicator. Constantly lower and lower yet the lows are higher and higher. Essentially it is stuffed into a corner. The CCI is also similar. RSI shows a 4 month positive divergence confirmed by the MACD and even more positive divergence the past week(s). Its also at long term trendline support. Strange market divergence as of late. VIX made some new lows and markets were a long ways from their highs.

So something is amiss. Either the market is going way up again or traders have become fearless even on this 50 point SPX decline. I opt for the latter. The fact that the CPC was .78 much of today yet the market kept sinking is a sign that option traders are now on the wrong side of the bet. So what does this mean? It means traders are complacent. It means the market will have to WAKE THEM UP to the realities of the world.

(EWI mentioned the CPC today - and its a great theme for today along with the VIX - they didn't mention that - and its gonna look like I'm aping their stuff - oh well - sometimes things standout that you get the same conclusion at the same time - such is how EW works. I wish I had mentioned this is my update prior to when their update came out)

Daily bullish sentiment was at 88% at the 930 SPX top and had rivaled the Oct 2007 top (hat tip EWI for that stat). That bullishness needs to be worked off. The only thing that can do that is a persistent decline.

Traders have not yet had that "point of recognition" moment just yet. The VIX and CPC confirms that hasn't yet happened. Probably since the market is still above "unbreakable" 875 support as if it is some kind of magic layer or something!

The put/call ratio (CPC) is like a wind at the market's back. It powers the direction of the market's moves until the wind becomes stale and the sails of the market start to tatter. The wind (calls) blows harder and harder and the market's sails are are so tattered (buyers are exhausted) that it cannot move anymore even with lots of traders blowing the wind. The ocean current then starts to take the market backwards and traders keep blowing more wind (call heavy) trying to get the ship moving upstream again. Well it just don't work and eventually the traders figure out they had better jump on board and ride the ship downstream (puts).

Eventually as the market decline wears on all the traders "get it" and jump on board the ship riding the puts downstream. The weight of the traders in a put heavy mode keeps the ship moving downstream until eventually it reaches the bottom of the stream and catches a small wind. The ship stalls and traders jump off and start blowing wind and the ship moves upstream again. These cycles can last a long time depending on what wave and degree your talking about. Then they repeat. This rally the calls have been heavy a long time and powered the market for a long time because there were lots of buyers and little sellers as P2 predicted (volume).

Well the market is at a point where the wind was blowing hard and the ship is drifting backwards. Sooner or later the traders will have their "point of recognition" (usually a big gap down) and this is when they realize they needs to start to jump on board the ship. This is what works off excess bullish sentiment. It works at the bottom in reverse. No more sellers the market goes up. No more buyers.....you get the idea now.

It doesn't mean this market is heading to new lows just yet. At some point bullishness will be worked off. This point will be the end of the (X) wave in a valid ABC corrective pattern. That's how EW theory works in a nutshell. How low it goes depends on how stubborn the traders are. Real fear and doubt must occur in a "dose" to some significant degree to allow the process to reverse.

You count a valid ABC correction and appropriate sentiment indicators are "worked off" and there you have your X wave bottom. That's what we do. That's why I do Elliott waves above all else. Above the "news" above the whatever. Its sentiment. That's what makes the markets work. Stay Tuned.

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