T2108 Update – August 9, 2011 (Finally Some Relief)

(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag.)

T2108 Status: 7.5% (Day #4 of the current oversold period).
VIX Status: 38.
General (Short-term) Trading Call: Finish building bullish positions. Hold remaining bearish positions.

Commentary

The S&P 500 had a strong close, finishing up 3% (see chart here). The volatility index came down 21% (see chart here). Neither index wiped away the impact of Monday’s trading. In the “fun with numbers” category, note that the S&P 500 technically hit bear market territory at 1101, the lows of the day, for a 20% (19.6%) loss from the April 30th intra-day high of 1370. On a closing basis, the index has had a maximum loss of 18% so far.

Despite these strong moves, T2108 only budged about 1 percentage point to 7.5%. I think this is a result of the extreme oversold conditions from yesterday. The good news is that if the rally picks up steam, there is a lot of room to the upside. If the market gaps up tomorrow, I suspect a lot of buyers will rush into the fray to avoid “missing the train.” If so, short-term traders should unload at least one position to lock in some profits and build up stamina to hold remaining positions through this oversold period. The trading call to finish building bullish positions is to advice not to chase stocks higher – continue buying on dips and in small amounts and target a final allocation. Keeping some bearish positions on hand allows some slight hedging in case of a true calamity.

Tuesday’s gains are no guarantee of a (short-term) bottom, but the odds have sure increased. The market was particularly volatile with sharp gains to start the day, a rapid fade into negative territory after the Federal Reserve’s latest announcement on monetary policy, and then a very sharp increase and ramp up into the close. The intra-day trading had all the makings of a final shake-out of sellers.

Source: Yahoo!Finance

The historical record supports strong odds that the stock market has hit bottom for at least this oversold period. In my article “Trade the Oversold Bounce” (free registration required to SFO Magazine), I found the following for oversold periods:

“The maximum VIX and the intraday low on the S&P 500 occurred on the same day 60 percent of the time and 70 percent of the time within one day (before or after).

The maximum VIX and the closing low on the S&P 500 occurred on the same day 43 percent of the time, but 83 percent of the time within one day (before or after). “

Given the tremendous spike in the VIX yesterday of 50%, we have very high odds that the S&P 500 has bottomed for now. Note, this does NOT mean the bottom will not get retested during this oversold period. This is why locking in some profits tomorrow, if the market offers them, will be good risk management.

One final reminder: “56 percent of all oversold periods last only one or two days…The average oversold period lasts six days. Eighty percent of all oversold periods end within nine days, and 90 percent end within 10 days.” I doubt this oversold period will be “average” since the drawdown was so extreme. So, prepare for some more dramatic days as the market works off these oversold conditions.

(For the trades I executed, see my twitter feed and/or the #120trade hashtag).

Weekly T2108

*All charts created using TeleChart:

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long shares and calls on SSO; long puts on VXX