Beware of the bull trap!

Today’s market action seemed to echo the words of Robert Browning: “God’s in his heaven, all’s right with the world.” Buoyed by AIG CEO Edward Liddy’s promise that some of the $165 million in employee bonuses would be returned to taxpayers (and the ones who won’t be returning theirs will at least have to give back a portion of it in income tax) along with the Fed’s promise to buy more mortgage backed securities and long-term Treasuries, the market was bathing in a sea of green. Pretty much every sector was up, including emerging markets and gold. There was a noticeable absence of decliners, although the dollar took a tumble. The VIX (volatility index) also closed down but still slightly above support at 40.

So, is now the time to take the money you’ve been hiding under the mattress and go long? Maybe, but I don’t think so. Today’s action was almost too good to be true and I’m betting that tomorrow’s action won’t be quite so rosy.

Here’s why.

The Trin is very bearish
The Trin is an acronym for TRading INdex. It’s a technical indicator developed by Richard Arms. Because of this, it’s also referred to as the Arms Index. The Trin is easy to understand. It’s given by the following equation: Trin = [# of advancing issues/# of declining issues]/[volume of advancing issues/volume of declining issues].

A Trin less than 1 is considered to be bullish because the market is advancing on expanding volume. A Trin greater than 1 is bearish for the opposite reason. The Trin typically hangs out in the 0.8 – 1.2 region, and when it moves much above or below that area, that’s when traders take notice. Extreme levels on the Trin signal that a reversal in market direction is imminent. (A Trin below 0.5 signals a short-term top; a trin above 2.0 signals a short-term bottom.)

For the past week, the market has risen as the Trin has fallen. Yesterday, it hovered in the 0.4 – 0.6 range and today it fell even lower, closing just above 0.30. This is a strong signal that tomorrow’s open will be lower.

The VWAPs are at extreme values
The Volume Weighted Average Price is a trading benchmark commonly used by institutions. It’s calculated by taking the weighted average of the prices of each trade. What it really measures is how much interest (or lack of it) there is in a stock. VWAPs on the order of 0-80 are mildly bullish; 80-150 is bullish; and 150+ is very bullish. Stocks trading below their VWAPs are those that traders are trying to unload. VWAPs from 0 – -80 is mildly bearish; from -80 – -150 is bearish; and below -150 is very bearish.

Today we saw positive VWAPs in the +200 to +300 range and virtually none on the negative side. This is another indication that stocks may be over-bought in the short term.

The moral of the story is that it might be a good idea to sit on your hands for the next few trading sessions. My stance won’t turn bullish until the VIX moves and stays below 40, although I’d really like to see it break 35. Remember that we’re not even half way through this credit crisis and there’s still a lot more pain to come in residential and commercial mortgage-backed securities and in the consumer credit space.

All is not right with the world just yet.

One Response to “Beware of the bull trap!”

  1. SC says:

    Great explanation of Trin- this looks like bear market bounce. GHuess I should have bought puts yesterday. W

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