On the Monday Radar

* Great Performance Idea - Research tells us that goal setting and review are very helpful to performance enhancement across fields as diverse as athletics and management. One way to review your performance (and simultaneously review market action) is to replay the trading day by taking frequent screenshots through the session. Dave Mabe of StockTickr offers a practical solution, using free Windows software.

* Market Views - The ball is in the bulls' court, Trader Mike observes. Abnormal Returns links a number of good themes, including how the smart money is currently positioned and how munis look attractive here. Corey takes a good look at gold.

* Trader Views - Chris Perruna offers a set of questions to help you assess whether you're built for full-time trading. See also wisdom from Tom Bulkowski after 25 years of trading and a great summary of insight from Tom compiled by Charles Kirk.

* The Real Housing Problem - Is inventory, inventory, and inventory according to Calculated Risk.

* Not Such Good Risk/Reward - Accrued Interest finds little edge at the long end, but looks for 1% rates and continued strength elsewhere on the curve.
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Trading Psychology and Trader Performance: Selected Posts From 2007 - Volume Three

Many thanks to readers for the comments and emails on the post collections from 2007. Here's more of the "Best of TraderFeed" for 2007, with selected posts from the third quarter:

* What research tells us about underconfidence, overconfidence, and decision-making bias; how we make decisions in hot and cold cognitive states; what traders can do when they lose confidence;

* Anticipating volatility for the stock market;

* How to use imagery to make behavior changes; using emotion to change emotion; how to lose well in markets;

* Ten principles of short-term trading that have served me well; a common, but losing strategy for short-term traders;

* Learning styles and their importance to trading performance;

* How to become your own trading coach; how to set goals for success;

* Mali's life lessons; five principles of personal growth;

* Evaluating your mood during trading; improving your ability to cope with trading stresses; how problems relate to past coping

RELATED POSTS:

Best of 2007 - Volume One

Best of 2007 - Volume Two
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Indicator Update for February 11th

* Highs/Lows - As you can see from the top chart, we moved lower last week, but new 20-day lows remain well off their levels of last month. We are likely to see divergences on further price weakness, something I'll be watching closely. Friday actually saw an improvement in new highs (516 vs. 449) and a reduction of new lows (394 vs. 607) relative to Thursday despite price weakness in the large cap indexes. Let's see if that translates into a bounce early this coming week.

* Overbought/Oversold - The Cumulative Demand/Supply indicator that I recently highlighted is now at a neutral level (bottom chart). Note that we're continuing to see peaks in that measure at lower price highs, which is exactly the pattern we look for under bear market conditions. So while I think we could be early in a process of bottoming, I'm still counting this as a downtrend.

* Sentiment - Short-term sentiment, as measured by the Adjusted NYSE TICK, turned distinctly negative last week following a period of considerable strength. Four of the past five trading sessions showed a distinct bias toward hitting bids among NYSE issues, a significant turnaround from the period following the January lows.

* Momentum and Strength - We continue to see weakness on a longer-term basis. Only 22% of stocks in the S&P 500 Index are trading above their 50-day moving averages; that figure is 32% for S&P 600 small caps and 20% for the NASDAQ 100 issues. Among the stocks in my basket, we see low Technical Strength readings. Only 3 stocks are trading in uptrends, 9 neutral, and 28 in downtrends. At -1840, the Technical Strength Index is definitely weak, though off the levels we saw at the January lows.

* Advance-Decline - We are hovering modestly above the January lows in the Advance-Decline line specific to the NYSE common stocks and the stocks in the S&P 500 large cap and S&P 600 small cap indexes. We actually made a fresh A-D Line low last week among the NASDAQ 100 issues.

In sum, we have backed off last week's highs and are poised to test the January lows on further price weakness. Should this occur, I'll be looking for divergences and possible buying opportunities. Although there are some good historical reasons for looking for a bottoming process going forward, it's also true that prices can move well below their downside momentum peaks before sustaining a turnaround. For that reason, I'm keeping powder dry at this point.

RELEVANT POST:

Last Week's Indicator Update
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Getting Close to a Bottom?

Here we see weekly new highs minus lows as a percentage of issues traded on the NYSE going back to 1981. What we can see is that a large number of bear markets ended with spikes in the proportion of issues making fresh 52-week lows. Specifically, we've seen 20% or more of stocks making new lows during the following periods:

* October, 1981
* May and July, 1984
* October, 1987
* August and September, 1990
* April, 1994
* September, 1998
* October and December, 1999
* September, 2001
* July and October, 2002
* May, 2004
* August, 2007
* January, 2008

Not all of these, of course, represented long-term bottoms. Nor did the market make an exact price bottom when the proportion of new lows peaked. For instance, we didn't see a price bottom in 1998 until October. The great majority of occasions, however, did represent bottoming processes of at least intermediate-term significance.

RELATED POSTS:

When New Lows Expand

Falling Markets and New Lows
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Saturday Potpourri

* More Trading Wisdom - Here's quite a bit from Charlie Munger passed along by an astute reader that complements my earlier link; it deals with The Art of Stock Picking. One particularly nice observation:

And the wise o­nes bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.

That is a very simple concept. And to me it's obviously right based on experience not only from the pari-mutuel system, but everywhere else.

And yet, in investment management, practically nobody operates that way.

* Recent Interviews - I've been doing a fair amount of interviews for the mainstream media lately. Here's a Bloomberg article that quoted me regarding Jerome Kerviel and SocGen; here's a related article from Paris that appeared on an Australian site. This one, posted to CNN Money, deals with the emotional world of financial advisers and their clients.

* Macro Perspectives - Lots of good insight on the PIMCO site, including their most recent investment outlook.

* Searching Financial Blogs? - Here's a search engine specific to financial blogs that can help you find posts on any given topic. The creators limited the search range to recognized blogs, so that you won't be inundated with splog content.
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Brief Take: Small Cap Relative Strength

As the bottom panel of this excellent chart from Decision Point indicates, the January lows brought a potentially important shift in market strength. Up to that point, the largest components of the S&P 500 Index were outperforming the smaller components. That meant that the relative strength of the unweighted S&P 500 Index vs. the standard weighted version was in a downtrend. This occurs when investors and traders are seeking the relative safety of large cap names.

After January's lows, however, we've seen steady outperformance of the unweighted version of the S&P 500 Index. This suggests bargain hunting in the smallest of the issues within the index, something that occurs when investors and traders are relatively open to risk. (Note how outperformance of the unweighted index was characteristic during the bull phase).

Nor is this the only indication of bargain hunting among smaller stocks. At the January lows, 8% of S&P 500 large cap issues traded above their 50 day moving averages; that figure is now 22%. When we look at the S&P 600 small caps, we find that 10% traded above their 50 day moving averages at the January low; that figure is now 32%--notably stronger than the large caps.

Should we see a retest of the January lows among the large caps with nonconfirmations from the smaller caps, I would view that divergence favorably. We saw something similar during the 2002-2003 bottoming process and during the bottoming processes in 1998 and 1990. For that reason, I'm keeping a close eye on the number of stocks registering fresh 52-week lows as we move lower in the large cap averages.

RELEVANT POST:

Indicator Update
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Leadership, Happiness, Frustration, and Motivation: Being Your Own Best Trading Coach

An interesting study suggests that leadership (or a lack of leadership) has an effect on workplace performance, but the effect is indirect. Positive leadership generates optimism among workers, which in turn leads to higher productivity. Negative leadership yields frustration, which reduces productivity. While leadership is thus important, what matters in the end is the mood of the workplace: optimism vs. frustration.

The implications for trading are profound. When we're trading, we are also serving as our own trading coaches. How we prepare for the day, handle winning and losing trades, and review our performance are ways in which we exercise self-leadership. If the leadership of our own trading careers yields frustration, the result is apt to be reduced performance. If we lead our growth and generate an ongoing sense of optimism, we're most likely to have productive market experiences.

How do you talk with yourself when you make money, but not as much as you would have liked? How do you talk with yourself when you lose money? How do you talk with yourself when you miss a solid trading opportunity? Our self talk *is* our self-management. If the way you talk to you would bring frustration if someone else used those same words to you, then you know you need to work on being a good (self) manager. What we feel while trading is a function of self-talk and how we exercise leadership over our trading careers.

RELATED POST:

Changing Your Self Talk
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Big Themes for a Friday

* Big Themes - One thing I'm finding as I work with traders in various settings is that even the ones who are trading short-term are aware of big market themes and how those are playing out on a day-to-day level. I try to emphasize some of those big themes in my Twitter posts; an excellent daily source is the Abnormal Returns blog, which culls themes from both blogs and mainstream media. Other sources I regularly scour are Charles Kirk's extensive link posts, the link updates from Trader Mike, and the weekend reviews of The Big Picture.

* Strength and Momentum - On Thursday we had 449 new 20-day highs and 607 new lows across the three major exchanges. That's a weakening from the 470 new highs and 431 new lows the previous day. Momentum improved, however, with Demand finishing Thursday at 72 (up from 45) and Supply at 65 (down from 104). Demand/Supply is sensitive to whether stocks finish the day relatively strong or weak, so when we get improved Demand/Supply on a day where we also log more new lows, it makes sense to look for signs of a short-term market bottoming process. It's when we see price weakness and *fewer* new lows that we typically get some of the best entries in terms of risk/reward.

* Majority of Stocks Not in Bull Mode - We still have only 29% of stocks in the S&P 500 Index trading above their 50-day moving averages. While that's above Wednesday's low level of 17%, it suggests that weakness is still dominant for many sectors. Indeed, only 40% of the SPX stocks are trading above their 20-day averages. Interestingly, a greater proportion of small caps (49%) are trading above their 20-day averages than large caps. On the other hand, we're only seeing 25% of NASDAQ 100 issues trading above that benchmark. That having been said, the majority of issues are off their recent 52-week lows: among NYSE common stocks only we had 40 new lows on Thursday. That level hit 700 at the January lows.

* Not Much Technical Strength - Among the 40 stocks in my basket of SPX stocks chosen equally from eight important sectors, we find that only 4 are in uptrends, 9 are neutral, and 27 are in downtrends. That is a meaningful turnaround from the recent highs, when we saw more stocks in short-term uptrends than downtrends. In such an environment, when trading against the direction of technical strength, I like to be quick to take profits; many of the best longer-term trades wait for bounces or pullbacks and then go with the direction of overall trending.

* Reflection - "Look at your life: who do you want to be before you die?": Reflective birthday performance in Beijing from CXS.

A Few Good Ideas for a Thursday

* When Selling Sentiment Can't Push the Market Lower - Above we can see the S&P emini futures and the NYSE TICK. Note the selling bouts in TICK, with raw levels in the -1000 range (blue arrows). Despite these selling squalls, prices held above their early AM lows. When intense selling sentiment can't push the market lower, we usually get a bout of short-covering, good for a short-term trade.

* The Many Causes of Misjudgment - Thanks to a very sharp trader who sent this my way. It's a must-read from Charlie Munger on "The Psychology of Human Misjudgment".

* Addictive Trading? - Thanks to a reader for bringing this NY Times article to my attention. I continue to believe that addictive trading is a topic no one (exchanges, educators, coaches) want to go near; it brings in too much business. Here's a post designed to assess possible trading addiction. Here's John Forman's advice on pursuing trading in a responsible manner.

* Biological Consequences of Stress - Excellent post from Sharp Brains on how stress affects the brain.

* Gloom, But Not Doom - Gallup finds consumer confidence in the economy on the wane.

Cross-Talk: Trading Mistakes and Learning Experiences

Dave Mabe, who has developed the excellent StockTickr service, asks the question on his blog: Which trading mistake is worse?

a) Taking bad trades

b) Failing to take good trades

Psychologically, these are very different mistakes. Taking bad trades (overtrading) is most often a function of overconfidence, frustration, or sheer impulsivity. It represents a relative absence of control.

Failing to take good trades, on the other hand, can be viewed as an overcontrolled behavior pattern. Anxiety and a lack of confidence are common reasons for not taking trades with an edge.

Many traders cycle between these modes: They become overaggressive, take bad trades, undergo losses, and then become overly risk averse and fail to take good trades. This is a deadly cycle, both emotionally and financially.

So which is worse? Neither: as we can see with those traders that cycle between the two, they're variations of the same trading problem--a loss of rule-governance. When we become emotionally stimulated--whether with anger or anxiety--we are apt to act in flight (don't take the trade) or fight (take any trade) mode. We no longer stay connected to trading rules and sound practices.

Neither mistake need be deadly if it becomes a cue to observe yourself and figure out why you are veering from your rules. Trading mistakes can be opportunities for self-analysis if you're able to catch yourself and enter a reflective mode. That is why I like to take a time out when I'm getting away from my goals and rules. We can't undo mistakes, but we can turn them into learning experiences.

RELATED POSTS:

Why Traders Lose Discipline

Discipline Problems
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Happiness and Success: Which Brings Which?

In my recent post, I cited research that suggests that very high levels of happiness may not be conducive to achievement. The flip side of this coin is that people who are happy tend to benefit from their happiness in relationships and work.

A large review of literature finds that people who report a high degree of happiness tend to be more successful than those who report relatively low levels of happiness. This is because happy people tend to seek out fresh goals, which in turn provide new sources of satisfaction. According to the lead researcher:

"...happy people frequently experience positive moods and these positive moods prompt them to be more likely to work actively toward new goals and build new resources."

Happiness also is positively correlated with positive perceptions of self and others and effective coping skills. This sets up a positive mirroring in which others respond favorably to our own positive moods and behaviors, creating fulfilling interactions and reinforcing our own feelings about ourselves.

An interesting example of this can be found in airline terminals when flights are cancelled or delayed. I make it a special point to smile and empathize with the harried airline staff in such circumstances. Other people, brimming over with frustration, vent at the staff. I've consistently found that the airline personnel will go out of their way for me in ways that they don't for the people who vent. I suspect this happens in many facets of life, from job interviews to social gatherings: people respond best to those who come across positively.

We normally think of success as bringing happiness, but the research concludes that the line of causation goes the other way as well: happiness brings success. We can only speculate how the maintenance of a positive mindset may bring indirect benefits to trading, from heightened motivation to clearer decision-making. When we're happy, we become forward-looking; that, in turn, energizes goals and their achievement.

RELATED POSTS:

Goal-Setting: What Works for Traders

Turning Setbacks Into Goals

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High Levels of Happiness: Too Much of a Good Thing?

An interesting report of research passed along by a reader suggests that people who are happy enjoy many benefits over those who are unhappy. Specifically, those who report high levels of happiness tend to be more successful in their work and social lives than those who claim low levels of happiness.

But what of the group of people who rate their happiness at the very top of the continuum? Do extreme levels of happiness lead to exceedingly happy outcomes?

According to the research of Ed Diener and colleagues, the answer is mixed. Those who report very high levels of happiness fare worse in achievement measures than those who claim high, but more moderate levels of happiness. How can this be?

One possibility is that the people who claim to be very happy are responding in a defensive way, refusing to acknowledge any life problems. Rather than reflect a true surfeit of happiness, the questionnaires might be capturing an elevated—and inaccurate—self- image.

Mitigating against this interpretation is the fact that the very high happiness group does report higher degrees of relationship success than other groups. It is in the area of achievement that they seem to fall short.

This raises another possibility. To be extremely happy, one must be fully content with one’s present situation. All of us have enjoyed moments of joy when everything just seemed to be perfect.

My experience with very successful traders is that few of them exhibit such joy. They experience pride in their success, but “content” and “satisfied” would not be words I would use to describe them. Once they reach their goals, they tend to move the goalposts. They view contentment and satisfaction as enemies, as emotional traps that can lead to stagnation.

That isn’t to say that successful traders are perfectionists: many times their goals are realistic (though challenging), and they don’t belittle their own achievements. Rather, they seem interested in achievement for the sake of achieving: they love the process of surmounting peaks. Once at the summit, they naturally look for other mountains to climb.

It takes a certain level of discomfort to move us to action—even if that discomfort is nothing more than perceiving the gap between the real and the ideal. Extreme happiness may represent a relative absence of discomfort: satisfaction with the real as it is. Is that a bad thing? It may yield a fine quality of life and seems to work well for relationships.

But it doesn’t seem to be the hallmark of the highest achievers.

RELATED POSTS:

Subjective Well-Being

Improving Well-Being
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Trading Psychology and Trader Performance: Selected Posts From 2007 - Volume Two

Here are more "best of 2007" posts from the second quarter. Happy reading!

* A visit with a world-class trader, who was also featured in my Trader Performance book;

* When performance coaching works, and when it doesn't; here's a guide to coaching for professional traders; a look at when coaching fails; what you need to become your own trading coach;

* What we can learn from trading and poker;

* How to change your self-talk; here's how to handle performance pressures; a framework for building self-efficacy.

* Here are some steps to take if you're losing money; here's what makes us lose discipline;

* Evidence that aspects of trading style are hard-wired; evaluating your personality and how it shows in your trading;

* The heroic dimensions of trading;

* What makes a trader's marriage successful;

* Assessing your strengths and why that's important

Cross-Talk: Three Winning Characteristics of Training Programs for Traders

In an excellent post, John Forman, author of The Essentials of Trading, notes the pitfalls of the trader whose primary motivation is to make a quick killing in markets. Going after large rewards generally brings large risks, and few developing traders are able to handle those constructively. Many traders with small accounts, needing to multiply their money rapidly, court "risk of ruin": the near-certainty that a string of (highly leveraged) losing trades will put them out of business.

John's advice is to build skills and allow the power of compounding to generate success for the long term. In other words, he is advocating building a career, not gambling to make large sums.

So how do training programs at successful trading firms operate? I'm working with several at present and find three common elements among them:

1) They Teach Real Information - The programs are run by experienced traders who share specific setups, risk management methods, and ways to execute ideas. In the beginning, trainees don't trade; they learn the ropes by listening to mentors and observing mentors trade. At one firm I'm familiar with, trade ideas are shared openly through the day so that trainees benefit from a continuous role modeling.

2) They Offer Opportunities for Skill-Building - The successful training programs don't leave traders to fend for themselves. Rather, they enable beginning traders to practice techniques in simulation mode or with very small size. The leaders of the programs then meet with the traders to review results, make suggestions, and guide the learning process. Until traders show that they can trade small and follow the rules they were taught, they're not given larger size to trade.

3) They Blend Standardization With Individuation - This is a subtle point, but an important one. First the training programs teach traders how to do it "by the book". They model specific skills and drill those in a standard manner. Later, however, as traders become familiar with the skills, they are encouraged to experiment and develop their own ways of following the core rules and principles.

What this means in practice is that the successful training programs for traders are content-rich, highly structured, and run in a hands-on manner. I'm finding that firms that execute their training programs well are attracting and retaining superior talent. Conversely, firms without these programs end up as revolving doors, as new traders cannot survive their learning curves.

John Forman makes the analogy to sports, and it's an apt one. The sports coach is one who teaches strategy and drills skills, who provides feedback and challenge, and who guides development. A training program for traders is not so different from a training program for athletes. It's all about learning the game, developing the skills, and then applying the skills in increasingly demanding environments.

The challenge for the independent trader is to draw upon such resources as online trading rooms for information and modeling of skills, followed by the implementation of a curriculum that systematically rehearses those skills. Research in fields as diverse as jazz music and chess suggests that entrepreneurial expertise development is possible when the performance activity provides ample feedback--something trading provides in spades. By observing what works in training settings at trading firms, we can better structure our own learning.

Trading Psychology and Trader Performance: Selected Posts From 2007 - Volume One

I went back to the 2007 TraderFeed posts on psychology and trading and pulled out some of the "best of the year". Here are some of my favorites from the first quarter; more to come. Happy reading, and thanks for all the interest and support!

* Flux and uncertainty create opportunity, in markets as well as psychology;

* Mastering psychology with therapy for the mentally well; setting goals; enacting your ideals; reprogramming your experience

* What makes the winners tick: Overlooked qualities of successful traders; six keys to trading success;

* A description of how I trade; tracking the market's largest traders; identifying breakout moves; my principles for short-term trading;

* How personality affects trading performance;

* Well-being, and why it's important, plus a questionnaire for self-assessment and how to transform stress into well-being.

* Sentiment and identifying the sentiment trend;

* Somatic markers and trading decisions;

* A technique for rapid behavior change;

* Traders don't always do what they should: Why traders self-sabotage; why traders don't trade their plans;
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Indicator Update for February 4th

* Persistent Strength - We can see from the 20-day new highs minus lows for the stocks traded on the NYSE, NASDAQ, and ASE that we have bounced sharply off the recent lows and have been expanding the number of stocks making new highs each day. Indeed, Friday closed with 1728 new 20-day highs against only 256 new lows. Among NYSE common stocks only, we had 31 new 52-week highs against only 6 new lows. This strength has been mirrored by the very positive sentiment expressed in the Adjusted NYSE TICK, which has closed positive 7 of the last 9 trading sessions and quite positive for the last two sessions. I generally have not found it profitable to fade the market for anything more than a short-term trade when such strength is evident.

* Momentum Strong as Well - My Demand/Supply Index was solidly positive every single day last week. That's an unusual amount of strength and suggests persistence of buying across a wide range of issues. My Cumulative Demand/Supply measure is in overbought territory per my recent post, but as long as Demand exceeds Supply and new highs are expanding, it is premature to sell this market. On a longer time frame, we now see 49% of SPX stocks trading above their 50-day moving averages, up from 8% at the market lows. The bounce has been equally strong among small caps, with 50% of the S&P 600 small caps now trading above their 50 day MA.

* Bullish Shift - Technical strength among the stocks in my basket has shifted to the upside, with 21 issues trading in uptrends, 10 neutral, and only 9 in downtrends. Two of the formerly weak sectors, financials and consumer discretionaries, are now solidly bullish, suggesting bargain hunting among investors. The Advance-Decline Lines for the NYSE common stocks only and for the S&P 500 stocks remain below their December highs, but have bounced well off their recent lows.

In sum, we've been seeing bargain hunting and persistent buying following the efforts to stabilize the markets with fiscal and monetary measures. I will need to see waning momentum, a rise in the number of stocks making fresh 20-day lows, and weakness in the technical strength numbers before anticipating any correction or retest of market lows.

RELEVANT POSTS:

Last Week's Indicator Update

Technical Strength by Sectors
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Themes to Begin the Week

* Buying Sentiment - Has been consistently strong of late. My Adjusted NYSE TICK has been in solid positive territory for 7 of the last 9 trading sessions. I break out buying and selling interest as separate variables from the TICK and we've been seeing both above average buying sentiment and below average selling. This has been a key factor in the steady expansion of fresh 20-day highs among stocks during that time. More on this tomorrow when I review the indicators.

* Links and Insights - Trader Mike's updated links include a very interesting post on daytrading and poker. Abnormal Returns links prospects for the rally and an insightful view of the lifecycle of hedge funds.

* Screening for Stocks? - Charles Kirk's readers name their top 10 stock screening tools.

* A Look at Breadth - Quantifiable Edges explores the breadth indicators and what they're telling us.

* Gold Rush - The Big Picture passes along an inflation-adjusted view.

* Hot Money - A Dash of Insight looks at ETFs and sector rotation.

What to Expect When Equity Options Traders Are Bearish

The above chart shows how spikes in the 20-day equity put/call ratio have corresponded to intermediate-term market bottoms. When equity options traders are bearish, it's paid to look to the upside for short-term returns.

Going back to 2006 (N = 519 trading days), I note that we've had 85 days in which equity put volume has exceeded equity call volume. Five days later, SPY has averaged a gain of .33% (50 up, 35 down). That is considerably stronger than the average five-day gain of .03% (238 up, 196 down) for the remainder of the sample.

When the daily equity put/call ratio has been below .60 (N = 41), the next five days in SPY have averaged a loss of -.03% (20 up, 21 down).

All in all, when the daily equity put/call ratio has been above .80 (N = 262), the average five-day gain in SPY has been .23%. When the ratio has been below .80 (N = 257), the average five-day loss has been -.07%. This has been a useful sentiment measure. At present, the ratio is .76, a six-day low.

RELEVANT POST:

Relative Sentiment and the Put/Call Ratio
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Tracking Cumulative Demand and Supply: From Oversold to Overbought

Regular readers are familiar with my measures of Demand and Supply. To briefly recapitulate, imagine a stock and its short and intermediate term moving averages. There is a volatility envelope (like Bollinger Bands) surrounding the moving averages. If the stock closes above both its envelopes, this qualifies as "Demand", as it shows unusually strong interest in the issue. If the stock closes below both envelopes, it is added to "Supply", suggesting unusual interest in selling the shares. Anything closing between the edges of the volatility envelopes is not added to the total. The Demand/Supply Index reflects the number of stocks trading above and below their envelopes across the NYSE, NASDAQ, and ASE.

When the Demand/Supply Index is summed as a cumulative total, we get an oscillator that is helpful for intermediate-term timing. The oscillator shown above subtracts the day's cumulative reading from the 200-day moving average to see how Demand and Supply are faring on a relative basis. As you can see, drops in this oscillator below -30 have corresponded to short-term market bottoms. Rises above +20 have generally led to topping processes and eventual cyclical declines.

Observe how we have gone, in fairly short time, from below -30 to above +20 with the sharp rally off the recent market lows. This doesn't necessarily mean we're going straight down, but it has served as a heads-up for a topping process and eventual correction.

I went back to the start of 2004 (N = 1003 trading days) and found 175 occasions in which the Cumulative DSI oscillator has been above +20. Twenty days later, the S&P 500 Index (SPY) has averaged no change (103 up, 72 down)--a subnormal return. Conversely, when we've seen the oscillator below -20 (N = 130), SPY has averaged a sizable twenty-day gain of 1.24% (94 up, 36 down).

It's when we've seen an overbought oscillator in conjunction with weakening new highs/lows that markets have been most vulnerable on an intermediate-term basis. Thus far in the market rise, new highs have been expanding steadily.

Finally, consider that in a bull market, peaks in the oscillator will occur at successive price highs. In a bear market, we see valleys in the oscillator at successive price lows. Recently, we've traced lower highs and lower lows with the oscillator extremes. For that reason, despite the vigor of the recent rally, I'm still considering us in a bear market phase.

An oversold reading on a successful test of market lows or at higher price lows would have me buying aggressively for the intermediate term. Price topping and weakening new highs/lows around these price levels would have me selling and going with the downward trend. The current overbought reading is a yellow light, but as the chart shows, markets can move higher following such a reading when new highs/lows remain robust.

RELATED POST:

An Unusually Sensitive Indicator
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Brief Take: China, Volatility, and the Winter Storm

I created this chart in Bloomberg to illustrate a couple of things about China's equity market. Here we see the past year of trading in the S&P 500 Index (green line; SPY) plotted on a ration chart against the CSI 300 Index (blue line; a cap-weighted index of leading stocks in Shanghai and Shenzhen). If we thought volatility was high in the U.S., see how China rose threefold from July to October and now has lost a third of its value during its 2008 decline.

Note the recent decoupling of the U.S. and China markets. While SPY has bounced nicely off its recent lows, we are making new 2008 lows in China. That, no doubt, reflects concerns regarding the impact of the recent fierce snowstorms in southern China. The impact of the storms is so profound that there are social and political ramifications, not just economic ones. Interestingly, articles emphasize that these impacts will be short-term and limited. Investors do not seem quite so convinced.

At any rate, the shortages of coal and food will exacerbate inflation in China. This comes at a time when the government is already fighting inflation by curbing the growth of credit. This is a disaster much larger than Katrina in the U.S., and the damage from that latter storm has yet to be undone. As in the New Orleans disaster, responses to the event were belated, as its severity only became evident over time. The slide show that accompanies this Forbes story illustrates the human side of this tragedy, but also clearly illustrates the frailty of an economy that, for all its volatile growth, remains one that is emerging.