Market Internals: Stocks held steady throughout most of the week of trading before falling victim to a nasty sell-off on Friday. Although the Dow Jones Industrial Average ($INDU) lost only 57 points on the session, volume on the New York Stock Exchange [NYSE] rose to its best levels of the week and up volume trailed down volume by a margin of more than two to one. Over on the NASDAQ Stock Market, volume also rose to its highest levels of the week as the NASDAQ Composite Index ($COMPQ) gave up 28.9 points and erased all of the week's hard fought gains. In the end, the Dow suffered a 73-point loss and the NASDAQ slid 16 for the week.

Sentiment Indicators: While the major averages suffered only modest losses on the week, the action on Friday was noteworthy for several reasons. For one, as already noted, it occurred amid increasing volume, which is generally a bearish sign. Second, it occurred following a period of quiet trading, as the major average tested and failed key resistance. It now appears that a downside breakout could be at hand. For example, Figure 1 shows the S&P 500 Index ($SPX). It has been attempting to break to new highs at 1,450 and has failed. Now, the move Friday pushed it below the lower band of the Volex (volatility indicator), which is hinting at a downside break down.

Furthermore, the volatile move lower on Friday occurs after a period when bullish sentiment has reached levels that hint at overbought market conditions. For example, the CBOE Volatility Index ($VIX) has been sitting at the lower end of its range. The VIX, which is also known as the market's "fear gauge" hit a mutli-year closing low of 9.89 on January 24. It spent most of the latest week of trading around 10.5, before jumping up to 11.10 on Friday  

Other indicators confirm that bullish sentiment has become quite high. Several, including the all exchange put to call ratio, the sentiment surveys, and the NYSE TICK, have been discussed in recent weeks. From a contrarian view of the markets, the relatively high levels of bullishness that developed since the summer of 2006 are a negative for the stock market because it all hints at overbought market conditions. In other words, once the selling starts, there is a risk that selling will beget selling as more and more bulls jump ship and move over into the bear camp.   

Looking forward, the next test might be whether or not there is a follow through to Friday's sell off early next week. Traders want to be on the lookout for a situation similar to May 2006 when Volex accurately warned of a downside breakout (see Figure 1). In addition, in the event of another market decline early next week, trendline failure will come into play and it might be time to look for opportunities to make some profits from a possible market pullback. On the other hand, a return to stability and a move back above S&P 500 resistance at 1,450 would offer an encouraging sign that the recent advance still has some upside potential. 

Sentiment Indicators—Past 7 Days

OPTIONS

Friday
(02/09)

Thursday
(02/08)

Wednesday
(02/07)

Tuesday
(02/06)

Monday
(02/05)

Friday
(02/02)

Thursday
(02/01)

Puts

1,634,592

1,216,943

1,175,605

1,112,353

947,407

1,153,585

1,222,969

Calls

1,736,641

1,442,549

1,294,728

1,295,039

1,150,376

1,187,444

1,453,260

Index Puts

859,315

590,664

541,048

544,603

397,136

556,204

604,074

Index Calls

598,457

341,482

349,441

262,624

203,882

330,538

382,720

Index P/C Ratio

1.44

1.73

1.55

2.07

1.95

1.68

1.58

Total P/C Ratio

0.94

0.84

0.91

0.86

0.82

0.97

0.84

VIX

11.10
+.66

10.44
+.12

10.32
-.33

10.65
+.10

10.55
+.47

10.08
-.23

10.31
-.11

VXN

17.11
+.97

16.14
-.03

16.17
-.44

16.61
-.23

16.84
+.41

16.43
-.68

17.11
-.08

TICK

+996

+772

+1,105

+872

+929

+652

+1,161

TRIN

1.20

1.03

1.25

1.31

.84

1.11

.82

CBOE PVI

1.36

1.04

.96

.90

.74

.86

.86

ISEE

111

116

115

141

146

97

142

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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