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Each week I receive an email from the Option Strategist (at no charge) which
succinctly overviews the week's action in the stock market, as McMillan
"sees" it. An extract of last night's email is appended. McMillan supports
his view with his favorite indicators which are also mentioned in his email
. Would anyone care to code these indicators for publication at
www.traders2traders.com <http://www.traders2traders.com> ?
Colin West
The Option Strategist HOTLINE
Stock Market
The rally since the market exhibited its deep oversold condition on
September 21st has been exceedingly strong. At first glance, it appears
that a V bottom has been formed by the market. A study of past market
movements indicates that V bottoms are very rare especially when the
market was in an as much trouble (i.e., was as deeply oversold) as this one
was. Such a deeply oversold condition routinely requires a retest of the
bottom at some point. I still expect that retest. In some ways, "too many"
people were looking for a retest (and probably a fairly quick one at that),
so by its contrary nature, the market did not do what the majority expected.
Many of those people no longer expect the retest, so it is much more likely
that one will occur eventually, but maybe not right away.
I had been thinking that the current market was similar to 1998, wherein a
deeply oversold condition was followed by a month-long rally (which
progressed at a leisurely pace) and then a retest of the bottom occurred..
However, the current market rally has been much stronger than the one we
saw in 1998. Now, I am leaning more towards the 1974 bottom as a potential
similar situation to today's market. At that time, the market was ending
the worst bear market since the Great Depression. A deeply oversold
condition was registered in October, and the market rallied swiftly and
strongly from 580 to nearly 700 a gain of nearly 20% in a matter of days.
Short sellers scrambled madly to cover, and naked call sellers were
decimated. Then some sideways movement followed before a retest got
underway. That retest reached its bottom during the first week of December,
1974, and thereafter the 26-year bull market was launched.
As I stated before and I repeat now, the market is never so accommodating as
to exactly repeat itself. However, the strong rally of 1974, followed by
the retest a couple of months later may be more the type of scenario we can
expect to see now. The rally we had over the past two weeks (which is
probably exhausted for now) was very strong stronger than the 1998 case
but that does not dissuade me from expecting an eventual retest of the
September 21st low (or at least the September 21st closing prices). I
still think it would fit better, historically, with the way markets often
bottom in October, to see that retest occur this month but the 1974 case
indicates that after such a strong initial rally, the retest may not take
place until closer to Thanksgiving.
As for individual indicators, they all gave buy signals from deeply oversold
conditions except or price. Both the normal equity- only put-call ratio
and the weighted equity-only put-call ratio are now on buy signals. These
buys are confirmed by the NASDAQ-100 (QQQ) weighted put-call ratio and by
the $OEX weighted ratio. The S&P 500 futures option put-call ratios are
tentatively on buy signals, too, although they are not confirmed yet.
Volatility ($VIX) peaked at 57 on September 21st and declined sharply
thereafter, leaving a spike peak in its wake. That is a buy signal for that
indicator.
Finally, market breadth improved greatly and that, too, is a bullish
sign.
But what's missing most noticeably is price confirmation. True, prices have
responded magnificently to the oversold condition even exceeding its
20-day moving average in the process. But what I'm talking about is the
classic higher high, higher low, higher high situation. In other words, the
current rally will end (actually, probably ended today in the short term)
and then a decline will take place. It is important that that decline make
a higher low. Then the final confirmation would be for prices to break
through today's high on the upside. That pattern is a powerful one, and
it's one we saw in April as the precursor to the good rally during April and
May of this year.
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