Extreme Conditions

The market is hitting massive extremes with regards to breadth, price, and volatility. Below is an incomplete list that illustrates just how severe current conditions are:



Take just about any of the conditions above, slice it in half, and under “normal” circumstances it would be extreme enough for a bounce a high percentage of the time.

Note: The top 3 breadth statistics come from Worden Bros. - T2106, T2114, & T2116.

CBI Finally Spikes

The CBI (Capitulative Breadth Indicator) finally spiked above 10 today and hit 12. For those who are unfamiliar with my CBI indicator, it basically uses a proprietary calculation to determine how much capitulation is evident among large-cap stocks. Spikes of 10 or higher in the past have led to market bounces on a fairly consistent basis. Those who would like more info on the CBI may want to read the intro post here or the full post history here. Until Tuesday the CBI had sat relatively dormant. I had thought the market might rebound before the CBI ever hit 10 this time, but this market seems bent on marking every extreme.

Until July, buying the S&P any time the CBI hit 10 or higher and selling it on a return to 3 or lower had a perfect record. The July trade turned out to be a loser. Below are statistics going back to 1995, which is as far as I was able to accurately reconstruct the indicator. The CBI has been tracked live for about 3 years now. All trades assume $100,000 into the S&P 500.



Impressive stats, but it’s important to keep in mind that the current environment is unlike anything we’ve seen since before data exists on this indicator.

An Off-The-Charts Example

As an example of the kind of extremes I was referring to in my previous post, below is a chart of (NYSE New Highs - NYSE New Lows) / Total Issues. New Highs are in the top panel. News lows are in the 2nd panel. Total issues are in the 3rd and the net percentage is in the bottom panel. Over 50% net of issues hit new lows yesterday.



According to my data, the last time the reading was under -50% was 10/19 and 10/20/87. Prior to that was 5/21, 5/25 and 5/26/1970, which is about as far back as my data goes.

Edit: It was pointed out in the comments section that Dr. Steenbarger also noticed this. His data went back prior to 1970 and he found an additional instance.

Everything Is Off The Charts

Most every indicator I look at with regards to breadth, volatility, and price action is strongly suggesting a strong short-term bounce should be at hand. Below is a short excerpt from Sunday night’s Subscriber Letter which puts some of my thoughts on these extremes into context.

What needs to be kept in mind is that the price action over the last week has been more severe than at any time other than 1987 and then back to the 1930’s. In other words, while extreme readings in breadth, volatility, price, and volume indicators of this magnitude have almost always led to short-term upside over the periods tested, the current situation is far beyond most everything tested. Measures need to be taken to control risk. Tight stops are a possibility, but difficult to implement with such extreme volatility. I’m controlling risk by scaling in with reduced position size.

An Elevated VIX Study

On Friday the VIX closed above 45 for the 2nd day in a row. This is the 1st time since the VIX has been measured back to in 1990 that this has happened. Meanwhile the VXO closed above 50 for the 2nd day in a row. The only other time readings this high can be seen were in a back-adjusted 1987 period during and after the crash. I ran some tests to see how the market has performed the week following back to back readings above other extremely high levels:

While the instances get low over 40, average profits of greater than 5% over the next 5 days across the board are quite impressive.

Another Example Of Unprecedented Volatility

Including Thursday there have been 18 days since 1960 where the S&P 500 has closed down 4% or more. Four of them have come in the last 3 weeks. The only other period to come close was the Crash of ’87 when it occurred on 10/16, 10/19, and 10/26. Of the previous 17 instances, the market finished higher the next day 14 times. All instances are listed below:

Recent volatility is tremendous, and this is just another example of it.

With such volatility comes opportunity. When looking to take advantage of edges during extreme periods such as this, traders need to make sure they are comfortable executing their plan. Otherwise they could end up as part of the panicked crowd. Trading while in a panicked state simply isn’t conducive to optimal decision making.

One last tip. Bailout news tomorrow could make for fast market conditions. Traders may want to place any stops they are planning ahead of the news. Otherwise execution may become difficult to impossible.

Strong Bounce, Weak Volume

A few weeks ago I showed how weak bounces have a tendency to quickly roll right back over. The good news is Tuesday’s bounce was far from weak. Tonight I decided to show a similar study examining strong bounces after a sharp move to new lows:

As you can see there tends to be an immediate and lasting edge when the bounce is sharp like we saw on Tuesday. There was a weak spot with Tuesday’s bounce, though – volume. It came in quite a bit lighter than Monday. Adding this filter changes the results to look like this:

While there is no negative implications in the first few days, the apparent lack of big buyers (volume) does seem to have a negative impact on returns after day 4.

Instances are a bit low, and many of them aren’t very comparable to current conditions. There’s a big difference between a rebound from a 2% drop and a rebound from an 8% drop. Therefore, I’d suggest the appropriate thing to do with this study is keep it filed for future reference. Then perhaps review some of the charts I posted last night.