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Extremes...What Do They Mean?

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Last October, these were good signs, so why not now?

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Much of what I look for hinges on extremes. Whatever I'm looking at, and however I define "extreme," I'm watching for outsized moves that signify exhaustion one way or the other.
We've seen no such shortage the past few days. Let me count the ways:
  • Odd lot short sales hit a new all-time record yesterday, besting its previous record set just on Friday.
  • The CBOE total put/call ratio yesterday reached its highest level in at least a decade, and has now recorded four straight days with more puts traded than calls (a very rare event).
  • Breadth over the past week has been so horrendous that it has been matched only a few times in the past five years. Each of them lead to an intermediate-term low.
  • Rydex traders have finally gotten back into their old groove and are getting extremely defensive – to a degree now that has coincided with lows most times.
  • ETF volume exploded yesterday, to new all-time highs in many of them. This is a good sign of traders seeking liquidity and has been an excellent buy signal in the past.
But I have problems with some of these.
As one example, much of the put activity on the CBOE has been in index options, a much less reliable gauge than if it had been in equity options. Prior lows have been accompanied by spikes in equity put volume, and we're not seeing that to a large degree now. Plus, the very smallest of options traders through last Friday were still buying to open more than 2.5 times as many calls as puts – not exactly panicky behavior.
It's also odd that we're seeing these readings so soon after "the market" had been hitting all-time highs. This smacks of an impulse move, which is usually just the beginning of something larger. Anytime new lows hit more than 5% of total NYSE issues within a week of the Dow hitting a new high, that index was lower a month later every time by an average of over 5%.
In the "A Look at…" series of articles I've been posting over the past couple of months, there has been a clear pattern of trouble brewing. One week's decline in most equities is not enough to clear those out, and given the impulsive nature of the losses so far, history suggests that this is more like an opening salvo than a last-ditch give-up.
So if traders take some of the extremes we've been seeing over the past week to heart and put capital to work, I don't think the rally will last and we should be looking up at this week's lows in the coming weeks.
No positions in stocks mentioned.

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