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[skyymaster]

The Wall Street Journal - September 10, 2007 (Copyright © 2007, Dow Jones & Company, Inc.) The stock market has been seeing exceptional volatility lately, of a kind that in the past sometimes signaled that stocks were getting ready to rally. Trouble is, some analysts worry that the rules may be different this time because the heavy and sometimes frantic trading practices of some hedge funds are skewing market behavior. The fear is that the data may be signaling something very different than in the past. This concern has taken on urgency after Friday's 249.97-point plunge in the Dow Jones Industrial Average to 13113.38, another day of unusual trading activity that spurred fears that stocks have farther to fall. The question on everyone's mind is, when will the market hit bottom? Analysts who dissect market movements have many theories about how to pick the bottom. One that has been effective is to look for days of exceptionally heavy selling, followed by days of exceptionally heavy buying. The logic: When stocks are approaching the end of a decline, investors tend to be in a panic, and their sell orders dominate trading. Then, once the selling runs its course, bullish investors step in with heavy buy orders that dominate trading and, in turn, signal the beginning of a rally. Lately, that combination of heavy selling followed by heavy buying is exactly what the market has seen -- on steroids. "We have been getting these days at the rate of one every 3 1/2 days, and that's just crazy," says Paul Desmond, president of research service Lowry's Reports in North Palm Beach, Fla., who has done extensive research on the subject. "We don't have anything like that anywhere in our history" of data, going back to 1933, he says. Heavy volatility can excite investors when markets are rising, but it is scary when markets are disturbed, as they have been lately. The trick is to figure out when the down volatility is running its course, and that is what seems to be getting harder to do. To identify one-way days, Mr. Desmond looks at total trading volume for all stocks that finished up and for all stocks that finished down. He also looks at the total price moves, in dollars, for those two groups. The days to watch are those on which 90% of volume was in the same direction, and 90% of price moves were as well. On the Friday before the 1987 crash, 90% of volume and 90% of price movement were accounted for by declining stocks, according to Mr. Desmond's data. On Monday, Oct. 19, 1987, the crash day, trading was even more heavily centered on decliners. But that was the low point of the selling. On Oct. 21, 90% of stock volume and price movement was up, indicating the worst was over. Similar days occurred at the bottom of the 1990 bear market. There was only one such day at the 2002 bottom, but several such days hit a few months later, in 2003, when the U.S. invaded Iraq and stocks fell almost to the 2002 low. After that 2003 decline, stocks entered the bull market that has continued until now. Since 2003, there have been few big declines and few heavy one-way trading days -- 10 in total from 2004 through 2006. The only significant grouping occurred in mid-2006, just as the market suffered a sudden slide and then recovered. So the signal seemed to be working a year ago. Now, the pattern of one-way trading has returned. Since stocks peaked on July 19, there have been nine such days -- six down and three up. Four down days came from July 24 through Aug. 14. Then there were three 90% up days in mid-to-late August, and two such down days, including a 90% down day on Friday. That represents more such swings than in 1987, before and after the crash. But other market indicators aren't nearly as shaken up as in 1987: the Dow industrials and the Standard & Poor's 500-stock index are down less than 10% from their highs. In the past, they would be down more than 20% before seeing so many heavy swings. Something isn't right. "I am not sure you can jump to the conclusion" that all this activity is signaling anything at all about the likelihood of a stock recovery, says Brian Luedtke, head of technical analysis at brokerage firm Piper Jaffray in Minneapolis. He and other analysts think the sudden increase in market volatility could be due to the growing role of hedge funds and other fast-trading investment vehicles, which on some days account for 40% of trading or more. Some hedge funds use computers to trade millions of shares at a time. Others trade heavily in exchange-traded funds, which affect broad baskets of stocks. If several huge hedge funds, using lots of borrowed money to expand their impact and following similar strategies, use computers to make similar trades at the same time, that can create huge one-way days, without signifying a lasting change in market sentiment. Ned Davis Research in Venice, Fla., has long tracked what it calls nine-to-one days based simply on trading volume -- days when 90% of the shares traded move in the same direction. There has been so much volatility of late that the firm has adjusted its system. For up days, it now counts only 10-to-one days, because there are simply too many nine-to-one days. "This used to be a good signal of a major bottom," says Tim Hayes, Ned Davis's chief investment strategist. "Now, it could be turning into a signal of the end of a less-significant market correction -- or it could be turning into an inconsistent signal" that simply means investors are anxious. Mr. Desmond of Lowry's was optimistic about the market's direction a month ago, but he now has turned more pessimistic. Other performance indicators he follows, involving the number of stocks that are rising and falling over longer periods and the strength of the market's recent efforts to rally, suggest to him that stocks may have farther to fall. Because other indicators are looking somewhat negative, Mr. Desmond thinks the recent surge in 90% days could be a false signal. For that, he blames, in part, the Securities and Exchange Commission. In early July, the SEC eliminated a rule that restricted a practice known as short selling, in which investors borrow stock and sell it in hopes of profiting if the stock's price declines. The old rule, instituted after the 1929 crash and aimed at preventing floods of stock selling, generally allowed short sellers to sell borrowed stock only on an uptick -- after a purchase had sent the price up. Now short sellers can sell at any time. Some academics, SEC officials and short-sellers have said that the rule change isn't having a significant effect on stocks and there was no reason to restrict short sellers. But many traders blame it for making it easier for hedge funds to sell stocks massively in a downturn -- after which they have more stock to buy back when they cover their bets, helping push stocks higher during an upturn. Mr. Desmond says he fears that the recent volatility will scare off ordinary investors, leaving the market increasingly dominated by hedge funds. "Now, when we are in a dramatic period of speculation, the SEC is saying, 'Let's speed this up some more.' It seems irresponsible," Mr. Desmond says.

[underabigw]

Sky, Thanks for the post. The 9 to 1 ratio issue has been on my mind a lot lately. Best of luck to you and thanks again! UBW

[skyymaster]

Your welcome. That is what I mean. "Every body" is bottom picking because of the ratio and that scares me for going long. If it was that easy why we all would make millions which then would be worthless

[Echo]

Sky, see my comments below. Also, the post includes data on 15:1 days. There are only a handful of them. See Jason G's comment on it (scroll to the March 2007 entry) in the link I provided. See the charts and examples he provides...Not saying we can't get more shakeouts down to spx 1430 or even lower, but a significant IT bottom is near or past. Based on Hurst 4.5 yr cycles, same and it is past. Echo

[skyymaster]

Sky, see my comments below. Also, the post includes data on 15:1 days. There are only a handful of them. See Jason G's comment on it (scroll to the March 2007 entry) in the link I provided. See the charts and examples he provides...Not saying we can't get more shakeouts down to spx 1430 or even lower, but a significant IT bottom is near or past. Based on Hurst 4.5 yr cycles, same and it is past.

Echo

Echo, thank you for your feedback. The above article is from WSJ. Now, can everyone win in this market on the same side? I think not, because that is what makes a market. Many will have to lose.