ISEE Red Candles

Okay, so I lied. I was planning to completely forget about trading during the Thanksgiving holidays but then I ran into this chart this morning and just couldn’t help myself:

This is the equities only portion of the ISEE chart. In response to some of the pitfalls in the traditional put/call ratio the International Securities Exchange (ISE) publishes their own modified version called the ISEE index. Unlike the old school p/c ratio the ISEE filters out trades from both market makers and broker/dealers. The ISEE further differentiates itself by using only opening long trades in it’s tabulations.

As such the ISEE presents a much clearer picture of how retail options traders are positioned. The ISEE also uses a different equation than the regular p/c in calculating their index. To formulate the ISEE, the exchange takes the modified call volume, divides it by the put side and then multiplies the result by 100. Hence the ISEE is always a whole number.

With a normalized p/c equation a higher reading symbolizes greater put activity to calls while the ISEE formula generates higher readings if call buyers outweigh put buyers. So while a traditional p/c ratio of .75 would mean more puts than calls an ISEE value of 75 is the exact opposite. Like the CBOE the ISE also offers updated calculations of their p/c index several times an hour.

Okay, now that we’re all on the same page you might get an idea where I’m going with this. The high spikes I highlighted mark extreme ISEE readings above 230, which just so happen to precede turning points by a few days. Now, let’s correlate these spikes with daily candles on the SPX:

As you can see the ISEE spikes precede turns by a few days, but they are very reliable. Hey, I prefer a few days early than a few days late. What’s particularly notable is the 247 reading last Tuesday, which is the highest as far as I can see back. It was followed by a 241 close last night, which would be a strong reading on its very own. So, chances are that a significant market decline is imminent, and it is most likely only a few days away.

We now again find ourselves at highly overbought conditions coupled with wide-spread divergences across various averages. Gold and other precious metals were up, with oil and natural gas down as well as the dollar down. The inverse correlation between the dollar and equities are beginning to soften as new extreme down moves in the buck are not accompanied by equally strong up moves in equities. I think Chris Carolan said it best:

The accelerating nature of the dollar decline and gold rally may finally have reached the point where any international earnings positives for stocks are outweighed by the downside of the obvious increasing monetary instability.  The markets look like they’re about to get scared again.

In other words – the dollar carry trade is running out of oxygen. I believe Karl ‘No Slave To Fashion’ Denninger made the same point just two weeks ago, and you might want to take a look at his latest update on the subject. Another strange new phenomenon is the VIX rising and falling in line with equities, which confirms Carolan’s point that fear is creeping back into the market. All this suggests that conditions are now favorable for a market decline. You have been warned.

I have been quite verbose on the notion that the thinly traded rally of past few days was designed to further discourage the bears and to shake out weak hands. I’m sure that many traders simply gave up and cashed out as to not to suffer from further theta burn throughout the long weekend. I myself was very tempted but did not yield to my emotions – which was for the better as the ES futures are down a whopping 25 points right now. Yes, this may be quickly reversed tomorrow or Monday but on a more medium term those ISEE readings are usually good for at least a one week reversal.

Weekend Reading Assignment

Our friends over at EWI have just released a free eBook, How You Can Identify Turning Points Using Fibonacci. It features 42 chart-filled pages of actionable Fibonacci techniques that you can add to your trading arsenal right away. It’s pretty good medicine and you’ll probably never look at charts the same way again. Created from the $129 two-volume set of the same name, this valuable eBook is offered free until December 2, 2009. Don’t miss out on this rare opportunity to change the way you trade forever – go here to download your free eBook.

Enjoy the rest of the weekend – I might pop in and out tomorrow but don’t expect me right at the opening bell – I’m sleeping in tomorrow

7:30pm EDT: A little update – I got fascinated with the ISEE and worked all day to import the data into Excel – here are some follow up charts for you guys:

Now, isn’t that a lot nicer? I have also highlighted all spikes above 135 and all drops below 100 in the past year.

Here is the ISEE 10-day MA version – the focus here is twofold: First we have divergences which seem to indicate that a medium term trend is running out of steam. Then we also have a pretty obvious channel to the upside, which seems to also be a precursor for turning points lately – it’s actually more timely than the pure data as of late. You might have noticed that we have not pushed into the upper channel line this time around, so perhaps more upside is a possibility.

This entry was posted on Thursday, November 26th, 2009 at 4:59 pm and is filed under Market Outlook, Trading Psychology. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.