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Pink-Sheet Stocks Plunge, Bottom Is Near


When speculators give up hope, turnaround may not be far behind.


One aspect of market behavior never changes: When times are very good, and have been for awhile, excessive speculation is a certainty.

We saw that in stocks leading up to 2000, housing leading up to 2006, and commodities leading up to 2007. Those are just a few examples, but one extreme generally leads to another: When speculation gets out of hand and those folks get burned, they tend to retreat in a major way.

The latest data related to "pink-sheet" stocks bears this out. "Pink sheets" is another name for the over-the-counter market, comprising several thousand stocks, usually priced under $1, for firms that don't meet the minimum listing requirements of the NASDAQ or other major exchanges.

Because these stocks can act like low-priced options (basically, they're lottery tickets), we often see a surge in volume when the market has been doing well. Even a $0.10 move can reap enormous gains if the stock was only trading at $0.05 to begin with.

The chart below shows total dollar volume in these pink-sheet stocks since 1995. In order to provide some frame of reference, the volume is expressed as a percentage of total NASDAQ dollar volume. Therefore, when we see a high reading in the indicator, it means that speculation is extreme - folks are trading these lottery tickets at an increased pace relative to "safe" companies listed on the NASDAQ.

Click to enlarge

The bubble in 2000 is very clear on the chart. Total dollar volume in the lottery tickets reached 3.5% of total NASDAQ volume in February of that year, just as the NASDAQ Composite (^IXIC) was topping out.

We haven't seen anything remotely like that since, so let's zoom in on the post-bubble years to get a better feel for recent extremes.

Click to enlarge

A few times over the past 5 years, we saw traders turning over these pink-sheet stocks to a relatively high degree, though it was hard to know in advance what constituted an "extreme," because there was no comparison to what we saw in 2000.

Currently, though, we're clearly at the opposite end of the spectrum. In October, total dollar volume in over-the-counter stocks fell to less than 0.07% of total NASDAQ dollar volume, the first time it has dropped below 0.1% since the inception of the data in 1995.

That's 32% less than the previous record low in July 2002. There were a total of 3 months when the percentage approached 0.1%: April 2001, September 2001 and July 2002. None of them corresponded with the end of the bear market, but the NASDAQ did manage a bounce in the following month(s) each time.

Before we can be optimistic about whether we're near another bear-market bottom, temporary or otherwise, we need to see some give-up among the most contrary of all traders: speculators.

From the trading in pink sheet stocks, it's safe to say we've seen that.

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No positions in stocks mentioned.

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