Friday's trading saw a torrent of sell orders hit the tape, as skittish investors all over the world found reason to take profits amid increasing uncertainties regarding corporate profits and global economic growth.
Several of the market indicators we follow at Schaeffer's Investment Research were tripped Friday as equity volume surged and equity prices plummeted.
The Desmond 90/90 Indicator, named after its founder Paul Desmond, looks for panic selling in the marketplace and was tripped on Friday, October 19. The indicator specifically looks for a trading day where 90% of volume and 90% of price action is negative. Panic selling often marks market turning points as investors liquidate holdings in a "Get me out of the market! Sell at any price!" psychology.
Often times, when we see such capitulation, bargain hunters step in and pick up perceived values such as depressed equity prices. Let's look at the S&P 500 Index (SPX) returns following Desmond 90/90 days, limiting the signal to 1 per every 30 days, as 2007 has seen an abundance of alerts.
Another market indicator we follow is the Traders Index, or TRIN for short. This indicator is also known as the ARMS indicator. This indicator peaked Friday amid the selling pressure and is a calculated using market breadth and volume. Peaks in the TRIN often coincide with severe draw downs in the equity markets and mark turning points that should be noted due to their infrequency.
For the below returns, we looked at a TRIN reading that was above 3.5, and the subsequent market action that followed. Friday's TRIN reading registered at 3.54. As you can see from the following table, SPX performance has been very robust after a TRIN spike above 3.5. In fact, we have seen positive equity performance post a TRIN reading above 3.5 for all of the 8 occurrences going back to 1993.
Another thing to note from Friday's sell-off was that odd-lot short selling increased as well. We monitor Odd-Lot Short Selling to gauge shorting activity amongst small retail traders, who break their orders down into "non round lots" or positions that constitute less than 100 shares (Round Lot). An increase in odd-lot shorting occurs at turning points, as retail traders either hedge long positions or speculate on a continuing drop in equity prices. Friday's odd-lot shorting figure was the highest daily total since August 16, 2007. If you look at a chart of the SPX, this is the exact day of the bottom in the late-summer pullback we experienced in 2007.
After reviewing these indicators and the accompanying returns, Friday's sell-off doesn't seem so bad. In fact, it was welcomed, as the increased volatility of the market has presented new opportunities for those inclined to use equity options and leverage to their advantage.
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