Guaging Stock Market Selling Avalanche Risk ~ The Risk Averse Alert

Thursday, August 28, 2008

Guaging Stock Market Selling Avalanche Risk

There is a serious problem being exposed by the trend in the volume of shares exchanged. It portends a certain prospect I have feared for some time, but have yet to write about. This is as good a time as any...

Trading since July's bottom exposes the fact fewer players, relatively speaking, are bolstering the market ... extending the very same tendency revealed the last time the market bounced (March - May '08).

This is an environment ripe for a selling avalanche.

Should volume's relative shrinking remain the norm while the market maintains its present buoyancy ... the threat of an awful collapse will only grow more acute.

An advancing market void of increasing selling demonstrates fearlessness. This is the antithesis to the wall of worry the market is said to climb.

Given today's systemic risks not seen for several generations, the apparent lack of worry among those who hold their shares (rather than sell, sell, sell) stands as a beacon — a virtual bell — which, I believe, any competent market historian dares not ignore.
This is why I advise the average investor not risk a dime in the stock market at the present time. This most emphatically goes out to tens of millions of clueless 401(k) participants.
Now, a lack of buying serving to add new positions also is responsible for diminishing volume since July's bottom, as is a lack of selling.

So, ask yourself, then... Would not strong hands increase their buying when an extended, positive period in the stock market is expected? Of course they would!

Twice already this year (March and July) strong hands have come to the rescue with high volume reversals following protracted declines. Yet their buying did not at all increase as the market rose. Instead, it was cut back. Why?

Clearly, strong hands have only been interested in buying time.

So, can we still expect a melt-up carrying various market indexes above peaks reached in '07?

Better first look for a powerful advance during which volume exceeds anything registered since the market's move higher got underway on July 15, 2008. Then we can be more certain strong hands are seeing green, despite our likely not knowing why this is.

Truth is this could happen. However, the fact of the matter is it has not. And because this is so, we ought be aware of the risk...

Should the combination of factors behind the market's diminishing volume of trade in some way or another persist over the weeks and months ahead ... a sudden stock market collapse could result — virtually without warning and almost overnight — in the event some earth shattering shock erupts.

Let me be clear. I am not forecasting this scenario's likelihood. Rather I simply am pointing out a potential vulnerability reflected by an ominous trend in the volume of shares traded over the course of 2008 in particular.

As you know, recently I have become suspicious toward the possibility of a market melt-up unfolding any time soon. In addition to the reason I just laid out — the volume picture speaks volumes, and this is irrespective of the fact its diminishing is heightening the potential risk of a selling avalanche — there really has been no compelling evidence strongly suggesting bottom to the market's decline since October '07 has been reached.

Recall what expectation I had over the course of the market's bounce March - May '08...

Rightly, I was anticipating a capitulation ... a sharp decline decisively taking out the low set on March 17, 2008. (You might also recall that, once this low was exceeded, many other observers similarly were calling for a capitulation.)

Did a capitulation in fact come to pass, though? Maybe. However, I have some serious doubts. What evidence I have thus far presented (via the McClellan Oscillator) just as well could be subtly inferring growing underlying weakness characterizing the market's tone (despite the suspiciously "well-behaved" manner in which the market fell from May - July '08).

Bottom line is, given the relative violence of market declines since Q3 '07, the most recent swoon hardly fits the picture of a capitulation. This was the point of my Final Jeopardy post back on July 10th.

More critically, the greater preponderance of technical evidence (outside the McClellan Oscillator) raises doubt about whether a pressure-ending sell-off has come to pass. Although I readily admit nothing is set in stone, being an Elliott Wave guy I simply must be mystified about the relative lack of technical confirmation supporting the case for a bottom-signaling capitulation.


A case in point in this regard is revealed by the Volatility Index. It seems this technical measure would likely confirm a fear-filled capitulation during a market sell-off anticipated to be severe. However, this simply did not happen going into July's bottom.

Now, had my Elliott Wave analysis not been calling for a crushing blow following the market's May 19, 2008 peak ... I might be looking at the VIX differently. I might be citing its divergent behavior over the course of the market's decline to a lower low as evidence supporting my melt-up thesis.

But that's not how I see it. At this point I would expect July's low soon to be taken out ... if, indeed, a market melt-up still is in store. Furthermore — and this is important — some additional underlying technical evidence of capitulation rightly should be expected. This should be revealed by the VIX in particular.

Chances are, though, the hour has passed on the possibility of a market melt-up. This in all probability will prove true even if July's low soon fails to hold.

The area highlighted on the above VIX chart coincides with the market's decline from October 11, 2007 through March 17, 2008. VIX performance during this period confirms an Elliott Wave view suggesting the market's ups and downs over the interim are related and form a discrete, declining impulse wave.

So, considering the market's decline to a lower low, May 19, 2008 - July 15, 2008, and seeing how VIX remained relatively subdued — diverging from what ultimately is its underlying basis: the S&P 100 — an Elliott wave view supposing the market's decline from October '07 - March '08 is but an initial move lower in a bear market with a long way yet to go gains probability. That VIX should have blown out ... but didn't ... becomes a red flag when considered in combination with volume analysis presented earlier.

Let me add one final thought. Elliott Wave-related prospects for major market indexes become much clearer at present when viewed from a perspective supposing a meltdown is in store sometime in the not-too-distant future.

Thus, evidence suggesting a heightened risk of a selling avalanche is all the more compelling and should not be ignored...

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Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

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