A skeptic is defined as someone not convinced something is true
and typically requires evidence to validate claims made by
others. In the world of investing, a contrarian falls into
this category. Count me as a big one.
On 12/13 we published an article entitled "3 Contrarian Signals
Flashing Red Alert" found
. The premise of the article was that complacency was at
extremely low levels often associated with market tops. The
indicators highlighted in that article worked well in warning us of
the late December short-term market top, helping us avoid the 4%
decline that started the following week.
Below I take another look at these indicators for signs of
#1 - Nasdaq Fear is Nearing All-Time Lows
The VIX (CHICAGOOPTIONS:^VIX) is one tool that measures
fear and complacency in the markets. When complacency is high
and fear is low, the VIX is low and markets are typically
Over the last five years the VIX has never closed below the 13
level, and the majority of the time the VIX was well above the 20
level. This past week it closed below 13 for the first time
since 2007 and is showing a real lack of fear in this market.
The VIX's cousin, VXN (CHICAGOOPTIONS:^VXN), measures volatility
of the Nasdaq 100 (NASDAQGM:QQQ). The chart below includes
some of the analysis from our latest Technical Forecast and shows
the extremely low current levels of the Nasdaq 100's (NASDAQ:^NDX)
Now around 14, these volatility levels were last seen at its all
time low level of fear in 2005, and, although didn't mark the exact
top in the Nasdaq, was a great level to purchase volatility
Volatility rose steadily from there eventually topping 75 in
2009. A similar occurrence happened near the year 2000 top
with the VXN rallying to over 80 from the 30 level in under a
After we noticed such low fear in December, we recommended going
long the VIX in the 15-16 range in our Technical Forecast and ETF
Profit Strategy Newsletter. On 12/28 the VIX reached 22, a
40%+ move in two weeks, where we also suggested taking profits.
("Volatility has Spiked, Now What?" found
With its price nearing all time lows, the VXN is telling us that
future market volatility and fear is expected to be as low as it's
ever been, and that is a contrarian sign that it likely won't be
anything near as calm as expected.
Although waiting for the Nasdaq's technical trend change to down
is the best way to play volatility, at such low historical levels
for longer term Nasdaq investors it may make sense to start buying
long term volatility hedges here.
#2 - Dumb Money Remains Long
In spite of the fiasco with MF Global, The Commodity Futures
Trading Commission does a great job at providing useful data for
investors, especially contrarians.
The Commission provides a breakdown of the "Smart" money and the
"Dumb" money based on classification between hedger or
speculator. Over the long run the hedgers are usually on the
winning side of the trade and the speculators the losing side.
In the face of the rally the last month (NYSEARCA:VOO), hedgers
have gotten more short and support a contrarian sell
On the other side of the trade, Russell 2000 (NYSEARCA:IWM)
speculators (the "dumb money") are longer now than they have been
in at least 4 years.
The previous time speculators were approaching this long, was in
February 2012, just before a 10%+ decline in the Russell 2000 index
We were able to use the Futures Commission's reports along with
our other tools on Silver (NYSEARCA:SLV) and Gold (NYSEARCA:GLD) to
help us identify a high probability opportunity in August.
On 7/29 when the "smart" money was net long and the "dumb" money
was short, the media and mainstream were bearish. SLV was
trading for $26.95 when we identified "SLV has broken out above its
long term downtrend resistance. Ths rising red short term
trendline support currently just above $26 is also a good stop loss
spot and support to watch. Good risk / reward setups such as
these are what we look for in our trading". When technicals
align with extremes in sentiment it often provides
Over the following month Silver and Gold took off, and exactly
one month later when Silver was at $29.75 we suggested, "Silver
broke down from its uptrend line and aggressive longs should have
exited by now for a great profit".
#3 - Actual Complacency is Back
In another sign of complacency, the actual volatility of the
market provides clues as to its future performance.
When actual volatility is low (as opposed to implied volatility
that the VIX measures), complacency among participants is
high. As the market's (NYSEARCA:IVV) actual volatility
lowers, traders and investors "let their guards down" so to speak,
and that is when bears attack.
This is supported by the historical data.
The above chart shows the S&P (SNP:^GSPC) at top with the
market's actual volatility based on its daily trading range (
) at the bottom. When price starts to move less than 10
points each day (identified by the vertical black lines), the
market (NYSEARCA:DIA) is typically close to a topping
This is eventually followed by periods of higher volatility
(usually on the downside), at least it has 10 of the last 11 times
it has occurred.
We also used this indicator in early December along with our
other tools to identify the short term top. On 12/12 when the
S&P was at 1428 we warned, "the 5 day ATR @ 11.86 is at levels
where previous tops formed. It shows complacency and the lack of
perceived risk in the market. A move below 10 would be an
even stronger signal."
Two weeks later the S&P was down to 1398. The ATR is
now again flirting with the lower levels again as complacency
returns to extreme levels.
With the Average True Range again bottoming, the VIX making 6
year lows, and the smart money still short, we are cautious about
chasing this rally. Instead we have identified key price
levels that will warn us to get out of the way, if the market is
again rolling over.
For more on these and other tools, the
Profit Strategy Newsletter
combines technical, fundamental, and sentiment analysis to
formulate high probability profit strategies. We publish a
monthly Newsletter along with a twice weekly Technical Forecast to
help our subscribers identify opportunities to put money to work
and better navigate the markets.
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