Market Internals Analysis

Sentiment Internal Indicators 1

Disclaimer It should not be assumed that the methods, techniques, or indicators presented in this book and seminar will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples in this book and seminar are for educational purposes only. This is not a solicitation of any order to buy or sell. “HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES IN THIS BOOK and SEMINAR HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS WE STATE MAY HAVE UNDER OR OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.” The authors and publisher assume no responsibilities for actions taken by readers. The authors and publisher are not providing investment advice. The authors and publisher do not make any claims, promises, or guarantees that any suggestions, systems, trading strategies, or information will result in a profit, loss, or any other desired result. All readers and seminar attendees assume all risk, including but not limited to the risk of trading losses. Day Trading can result in large losses and may not be an activity suitable for everyone. Copyright © 1994-2007 by Pristine Capital Holdings, Inc. All rights reserved. Printed in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without prior written permission of the publisher. 2

Table of Contents Introduction What moves stocks? Why use Market Internals Ways of Interpretation Historical Levels and Time Frames Course Goals & How to Use

Breadth Indicators Definition, Importance and Interpretation in Short and Long Term Time Frames Advancing Stocks and Volume Ratios, New Highs, New Lows TRIN, McClellan Oscillator, Advancing Stock Ratio and more

Sentiment Indicators Determining when the crowd is too bullish or bearish Equity, Total and OEX P/C Ratios Volatility Index (VIX and VXN) Bulls vs. Bears Sentiment Surveys

Intra-Day Internals TICK TRIN Trading relative strength and weakness Sector Lists Reversal Times Advanced TICK Analysis Advanced TRIN Analysis Advancing minus Declining Stocks Advancing minus Declining Volume. 3 Total Put/Call Ratio

Market Internals Analysis What Moves This Whale and How Market Internals Time Entries? The stock market acts as a discounting barometer that reads fundamentals, technicals, and the beliefs of participants all over the world. Sector Analysis

Bonds Commodities Currencies

Sector strength and weakness

Market Internals Breadth

Compelling Technical TPMs Pattern

Sentiment Inter-market

Enter per Trading Plan Manage in between

Reversal Times TPMs

Advance-Decline, Volume, etc. Bull-Bear %, Put-Call, etc.

Stocks

Inter-Market Analysis

4

Market Internals Analysis Why Use Market Internals?

Market Internals provide an objective comparison between the current market environment and the past based on historical references. Market Internals act as gauges that provide us a bias based on what the market is actually doing, rather than relying on others’ opinions. Similar to a pilot using an airplane's instruments, internals give early warning signals of possible or imminent danger at extremes. Market Internals give us the confidence to hold existing positions, despite prices being extended short-term. 5

Market Internals Analysis Getting The Most From This Short Course It is imperative that you understand how to interpret the internal’s patterns, then review historical levels as well as current ones to gain a working perspective.

Internals are not a magical black box. They form different patterns in different market environments, which I will show you. They also lead market turns.

I will show you how to use this information to determine market turning points when multiple internals are in alignment. 6

Market Internals Analysis Methods of Interpreting Indicators By first reviewing historic extreme levels of an indicator, we can determine trigger levels that may guide us to turning points in the current market. Points of observation in reviewing Indicators: Trend and support and resistance Historical extremes Speed that an indicator moves between extremes The patterns formed at overbought or oversold levels Divergences between price and the Indicator 7

Market Internals Analysis Bell Curve and Extremes Normal Distribution

A bell curve is a plot of normal

Extremes

distribution of a given data set.

Extremes

To create our alert levels for any Market Internal, we will encompass about 85 - 95% of the data’s range. Extremes

Alert Areas

Top and bottom lines alert extremes.

Extremes Alert Areas

8

Market Internals Analysis Historical Extremes are based on the internal’s prior reversal areas, not the market’s price data. Alert “areas” are where the indicator reversed over an extended period of time. Then compare those alert areas to the market for tradable events. Moving Average (1.01979)(CLose - 10-MA)

Jul

Aug

Sep

Oct

Nov

Dec

2003

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

1.100 1.095 1.090 1.085 1.080 1.075 1.070 1.065 1.060 1.055 1.050 1.045 1.040 1.035 1.030 1.025 1.020 1.015 1.010 1.005 1.000 0.995 0.990 0.985 0.980 0.975 0.970 0.965 0.960 0.955 0.950 0.945 0.940 0.935 0.930 0.925 0.920 0.915 0.910 0.905 0.900 0.895 0.890 0.885 0.880 0.875 0.870 0.865

Nov

Dec

2004

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

9 9

Market Internals Analysis The speed that an indicator moves between extremes - A sharp, fast move from one extreme level to the other (A) indicates strength in that direction. How it became overbought can actually suggest higher prices and vice versa. 1170 1160 1150 1140 1130 1120 1110 1100 1090 1080 1070 1060 1050 1040 1030 1020 1010 1000 990 980 0.7 0.8 0.9 1.0

A

A

1.1 1.2

A

1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2

8 eptember

15

22

29

6 October

13

20

27

3 10 November

17

24

1 8 December

15

22

29

5 2004

12

20

26

2 9 February

17

23

1 March

8

15

22

29

5 April

12

10

Market Internals Analysis The patterns formed at OB/OS levels: Basing at an OB/OS levels indicates strong market breadth. Consolidation often occurs after a sharp move between extremes. A V-type reversal after a move between extremes indicates weak market breadth. V-type reversal

Overbought (OB)

Basing at extreme

McClellan Oscillator (44.7479), McClellan Oscillator (44.7479)

230 220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -130 -140 -150 -160 -170 -180 -190 -200 -210 -220 -230 -240 -250

Oversold (OS) 13

20

27

3 10 November

17

24

1 8 December

15

22

29

5 2004

12

20

26

2 9 February

17

23

1 8 March

15

22

29

5 April

12

19

26

3 May

10

17

24

1 7 June

14

21

28

6 July

12

19

26

2 9 August

16

23

30

7 13 September

20

27

4 11 October

11

Market Internals Analysis Divergences between market new lows and indicator lows (higher lows) indicates internal market strength in a downtrend and vice versa. 1550 1500 1450

Bearish Divergence

B

1400 1350 1300 1250 1200

Bullish Divergence

1150

A

1100 1050 350 300

B

250 200 150 100 50 0 -50 -100 -150

A 7 14 ust

21

28

5 11 18 September

25

2 9 16 October

23

30 6 13 November

20 27

4 11 18 December

26 2 8 2001

16 22

29

5 12 February

20 26

5 12 March

19

26

2 9 April

-200 -250 16

23

30 7 May

14

21

29 4 11 June

18

25

2 9 July

16

23

30 6 Augus

12

Market Internals Analysis Course Goals By understanding how to interpret the internals’ patterns and noting their historical levels as well as current ones, we can gain a working perspective. Realize that internals are not a magical black box. They form different patterns in different market environments and trigger levels can change. My goal is to objectively show you how to use this information when multiple internals are in alignment, with price always being the final reason to trade. Roll up your sleeves and get motivated as the end journey will be well worth it! 13

Sentiment Analysis

Sentiment Analysis Breadth indicators focus on market data to show buying/selling pressure as it relates to historical reference points. Sentiment indicators focuses on traders’ expectations or beliefs about the future of the market whether bullish or bearish.

Based on contrary opinion, the risk of a market pullback is high when the majority are in bullish agreement. When the majority are in bearish agreement, odds are for an advance since most have already placed their “bearish trade,” and few sellers are left. At extremes in sentiment, our bias will be to act in the opposite direction when other internals and price suggests. 15

Sentiment Analysis Put-Call Ratios tell us whether people are bullish or bearish in the option market. We will focus on: Equity P/C RATIO Total P/C RATIO OEX P/C RATIO Volatility Index (VIX and VXN) The Market Vane Survey Investors Intelligence Survey American Association of Individual Investors Survey

16

Put/Call Ratios

Sentiment Analysis Option traders who believe an equity or index will decline buy puts (right to sell stock) to profit from a decline or hedge against long exposure, Bearish. Option traders who believe an equity or index will rise will buy calls (right to buy stock) to profit from an advance or hedge against short exposure, Bullish. Dividing the total volume of puts into the total volume of calls traded gives a “put to call ratio” and prior extreme reference points of sentiment. The higher the level of a P/C Ratio, the more bearish traders are; “think” bullish equities. The lower the level, the more bullish traders are; “think” bearish equities. At extremes, odds of a market reversal increase. 18

Sentiment Analysis Charting the Put Call Ratio Put Volume / Call Volume = Put/Call Ratio 326,048 / 376,267 = .86653 750000

Put Volume

Call Volume

700000 650000 600000 550000 500000 450000 400000 350000 300000

326,048

Bearish Bets April

May

250000 200000

June

July

Bullish Bets April

August

376,267

May

Put / Call Ratio

.86653

April

May

June

July

August

June

July

1050000 1000000 950000 900000 850000 800000 750000 700000 650000 600000 550000 500000 450000 400000 350000 300000

August

1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55 0.50 0.45

19

Sentiment Analysis The Equity Put/Call Ratio is the total volume of puts divided by the volume of calls traded on the CBOE on individual equities alone. The Total Put/Call Ratio is the total volume of puts divided by the volume of calls traded on the CBOE on individual equities and indices. The Equity and Total Put/Call Ratios are contrarian indicators. These traders tend to be wrong at turning points and are the “dumb money.”

The OEX Put/Call Ratio is Not a contrarian indicator. Traders buying these options tend to be correct and are considered the “smart money.”

20

Sentiment Analysis P/C Ratios have high and low extremes, but they can also trend. During bullish markets, ratios tend to trend lower; bearish markets higher. Using a price channel around the ratios works well for locating extremes as the market environment changes from bullish to bearish and vice versa. By inverting the Equity and Total P/C Ratios (dumb money), their high and low extremes should be in alignment with highs and lows in the market. The OEX Ratio (smart money) is not inverted. 21

Sentiment Analysis Put/Call Ratios will trend upward in a bullish market and downward in a bearish one. For this reason, using high and low price envelopes will track extremes better.

Excessive Optimism

Ma

rke tD

nd e r t Up

own

Excessive Pessimism

2000 was a peak high for the market and Total Put/Call Ratio (both reached extreme optimism) 1995

1997

Scale Inverted

1998

1999

2000

2001

2002

Ma

tU e k r

p

Scale Inverted 2003

2004

0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 1.15 1.20

22

Understanding Envelopes Percentage envelopes around a moving average trend with prices, as well as provide extremes based on historical price movements

%

%

MA

% %

23

Sentiment Analysis 0.5 0.6 0.7

At (A), was an indication of very extreme bearish sentiment.

0.8 0.9 1.0

Equity P/C Ratio (A)

Scale Inverted Apr

May

Jun

Jul

Aug

Sep

Oct

1.1 1.2

Nov

Bullish levels are .9 to 1.0; bearish levels are .55 to .45

0.6 0.7 0.8 0.9 1.0 1.1

Scale Inverted Apr

May

(A) Jun

Jul

Aug

Total P/C Ratio Sep

Oct

Bullish levels are 1.05 to 1.15; bearish levels are .7 to .6

1.2 1.3

Nov 2.5

OEX P/C Ratio

2.0 1.5

Bullish levels are .6 to .8; bearish levels are 1.8 to 2.0

1.0 0.5 Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

24

Sentiment Analysis 0.45 0.50 0.55 0.60 0.65 0.70 0.75

Scale Inverted 004

Mar

Equity P/C Ratio 5-MA

Apr

May

Jun

Jul

Aug

Sep

Oct

10% 20%

004

Mar

Apr

Total P/C Ratio 5-MA May

Jun

Jul

Aug

Sep

Oct

0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 1.15

1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

movements of all P/C Ratios.

A 10 and 20 % envelope around a 100-period MA (not shown) of the 5-MA will track extremes.

Nov

OEX P/C Ratio 5-MA

004

be used to smooth the weekly

Nov

20% 10%

Scale Inverted

0.80 0.85 0.90

A 5-period moving average will

Nov

The ratios are not in alignment.

The dumb money traders are bullish and the smart money traders are as well. 25

Sentiment Analysis 1150 1140 1130 1120 1110 1100 1090 1080 1070 1060

S&P 500

Equity P/C Ratio 5-MA Dumb Money buying calls

Total P/C Ratio 5-MA

0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90

Scale Inverted

Dumb Money buying puts Dumb Money buying calls Scale Inverted

Dumb Money buying puts OEX P/C Ratio 5-MA

1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7

Smart Money buying puts

Smart Money buying calls April

May

June

July

August

September

0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 1.15

Novem

Put/Call Ratios act like market sentiment oscillators. In downtrend markets, sell signals will have better odds. In uptrend markets, buy signals will have better odds. In a sideways trending market, buy and sell signals typically have similar odds.

At the August breakdown all P/C Ratios are aligned. 26

Sentiment Analysis Scale Inverted

0.45 0.50 0.55 0.60 0.65 0.70 0.75

A 21-period MA will be used to smooth the monthly movements of all P/C Ratios.

0.80

Equity P/C Ratio 21-MA A M J J A S O N D 2004

A

M

J

J

A

S

O

N

Scale Inverted

0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

Total P/C Ratio 21-MA A M J J A S O N D 2004

A

M

J

J

A

S

O

N

A 10 and 20 % envelope around a 200-period MA (not shown) of the 21-MA will be used to track sentiment extremes.

Not aligned 1.4 1.3

The trend of the bands are an 1.0 indication of overall sentiment. 1.2 1.1

0.9

OEX A M JP/C J Ratio A S O 21-MA N D 2004

0.8 A

M J

J

A

S

O

N

27

Sentiment Analysis Bear M

1500

arket

1400

Bu

S&P 500

t rke a ll M

1200 1100

800

Transition

0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80

Scale Inverted

(B)

0.8

(A)

OEX P/C Ratio 21-MA

Scale Inverted

years in the Total P/C Ratio was a sign of strength (B).

1.7 1.6

(C)

1.5 1.4 1.3 1.2 1.1 1.0 0.9

A

upper extreme in over two

0.9

Total P/C Ratio 21-MA

J

A first time move to the

0.6 0.7

A M J

was a signal of capitulation.

0.4 0.5

S O N D 2001

Equity and Total P/C ratios

1000 900

Equity P/C Ratio 21-MA

An extreme low (A) in the

1300

S

N

D 2002

A

M J J

A

S O N D 2003

A M J

J

At (C), OEX traders were betting on a decline while the dumb money was not. 28

Sentiment Analysis S&P 500

1150 1100

Once the market moved into a

1050 1000 950 900 850

bull phase in 2003, the 21-day Equity and Total P/C Ratios did

800 750

Scale Inverted

Equity P/C Ratio 21-MA

not move to lower extremes.

0.50 0.55 0.60 0.65 0.70

A Total P/C Ratio 21-MA

The break of a P/C trendline

0.75 0.80

Scale Inverted 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

A

signals a change in sentiment.

In 2004, option traders turned (A) bearish. OEX traders were

OEX P/C Ratio 21-MA 1.4

bullish. Smart or Dumb money?

1.3 1.2 1.1 1.0

A

0.9

Bull markets are supported

0.8 A

M

J

J

A

S O

N

D

2003

A

M J

J

A

S

O

N D

2004

A

M J

J

A

S

O

N

by bearish sentiment.

29

Sentiment Analysis The Equity and Total P/C Ratios are used as contrarian indicators and the OEX P/C Ratio is not. It is best when all are in alignment. Daily extremes can be an early signal of a market turn. The trend of the Put/Call Ratio suggests a market’s bullish or bearish bias. Buy & sell signals will have greater significance dependent on market trend. Alerts are given when a P/C Ratio moves from one extreme to the other. A first time move to an extreme, after an extended trend, can signal change. Put/Call Ratios are an excellent sentiment and market timing internal, but must be used with other internals and price pattern confirmation.

30

Sentiment Analysis The Chicago Board Options Exchange http://www.cboe.com reports the daily closing Put/Call for the Equity and Total Ratio each day. You can request to be e-mailed each day’s closing values at the site.

The intra-day Put/Call Ratio values can be seen at the site as well. They are updated every half hour. http://www.cboe.com/data/IntraDayVol.aspx

A rising market with a rising Put/Call Ratio (more puts) is bullish, and suggests a continuation of the uptrend. A falling market with a falling put/call ratio (more calls) is bearish, and suggests a continuation of the downtrend.

Historical data - http://www.cboe.com/data/PutCallRatio.aspx

31

Volatility Indices

Sentiment Analysis Volatility Index (VIX) The VIX, and VXN measure traders’ expectations of future volatility, or lack thereof, by measuring options activity in the S&P-500 and the Nasdaq. When traders become fearful, many go to the options market to purchase puts (right to sell stock). Part of option pricing includes “expected volatility,” which increases with uncertainty (e.g., pending news like earnings, Fed announcements, a falling market). When expectations are for higher volatility in the market, which is reflective of a bearish view, the VIX rises (expansion in risk premium). When expectations are for lower volatility in the market, which is reflective of a bullish view, the VIX falls (contraction in risk premium). 33

Sentiment Analysis Volatility Index (VIX) The VIX is an INVERSE indicator, which means that high readings of volatility (i.e., excess market bearishness) suggests “think” bullish equity trades; and low readings of volatility (i.e., excess market bullishness) suggests “think” bearish equity trades. We will also display the VIX as an oscillator with an inverted scale, so oversold readings will show at the bottom of the chart, and vice versa. Like all oscillators, the triggers are determined by applying normal technical analysis to it, confirmed by a reversal in price of the market.

VIX High

VIX Low

34

Sentiment Analysis 1500

The VIX and the VXO track

S&P 500

1000

each other almost identically. The LTCM

500

50 45 40

Old VXO - OEX

35 30

values are slightly different. A falling Volatility Index is generally associated with a rising market, and vice versa.

25 20 15 10 45

During the late 1990s, the opposite actually occurred.

40

New VIX - S&P 500

35 30 25

While levels change over time, upward moves do indicate traders’

20 15 10 1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

expectations for higher volatility. 35

Sentiment Analysis Candle Language of VIX Suggests Possible Market Direction. Doji corresponded with market bottom. The Volatility Index forms Support and Resistance Levels.

COG

COG

COG

36

Sentiment Analysis We gain valuable information from the trend of the Volatility Index; however, it may not be as helpful in determining turning points. VI

Xd

ow

n, M

ar k

et

up

Buy Signal

The VIX is interpreted like everything in the Market: Supply and Demand! 37

Sentiment Analysis VIX.X

Retest suggests reversal

S&P 500

VIX indicated complacency during the market sell off.

While there wasn’t price support here, the VIX suggested a possible reversal any day. 38

Sentiment Analysis Prior VIX high reference point

(B)

Using the VIX or VXN: The VIX confirms an

VIX did Not Breakout (A)

index’s move when it is forms an inverse pattern. Non-confirmation of a breakdown by the VIX

Opposite Patterns Confirm

Opposite Patterns Confirm

breaking out (A) suggests complacency and continuation of the

Breakdown

index’s prior move.

(A) VIX did Not confirm

Prior highs or lows in LL

the VIX show potential

(B)

turning points (B). 39

Sentiment Analysis VXN and 10-MA

30

25

VXN divided by its 10-MA (1.0 it where the close and the 10-MA are equal)

20

10-MA

C / MOV(C,10,S)

1.10 1.05 1.00 0.95

VXN Oscillator provides a historical reference of the ratio between the VXN and its 10-MA.

0.90 0.85

10-MA of VXN divided by its 10-MA 1.05 1.00 0.95 0.90

NASDAQ 100

1550 1500 1450 1400 1350 1300

November

2004

February

March

April

May

June

July

August

September

40

Sentiment Analysis Nasdaq VXN Oscillator (Inverted Scale)

April

May

June

July

August

September

October

0.89 0.90 0.91 0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 1.09

May

June

July

August

September

0.89 0.90 0.91 0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 October

level for the VXN is between .97 and .94. Historical oversold is between 1.02 and 1.05.

Novembe

S&P VIX Oscillator (Inverted Scale)

April

Historical overbought

Novembe

Historical overbought

level for the VIX is between .95 and .92. Historical oversold is between 1.03 and 1.06.

41

Sentiment Analysis VXN

10-MA

VXN Oscillator Inverted

31 30 29 28 27 26 25 24 23 22 21 20 19 18 0.90

The VXN reversal patterns will be used as a guide to confirm reversal patterns in the NDX.

0.95

1.00

Use the VXN Oscillator with other

1.05

sentiment gauges to NDX

1550

determine extremes in

1500

sentiment.

1450 1400 1350 1300 October November

2004

FebruaryMarch

April

May

June

July

August

September Octob

The VIX will be used in the same way. 42

Sentiment Analysis DOW MINI Futures

The

Oscillator gives warning signals to price turning points 0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00

VIX Oscillator Inverted

Overbought

1.01 1.02 1.03 1.04

Oversold

1.05 1.06 1.07 1.08

3 May

10

17

24

1 June

7

14

21

28

6 July

12

19

26

2 August

9

16

23

30 S

43

Sentiment Analysis REVIEW The VIX and VXN indicators typically move inverse to markets. The VIX and VXN candle patterns should be opposite to the markets. When the VIX or VXN do not confirm its index’s downward movement, it suggests complacency and lower prices. Prior highs and lows in the VIX and VXN will be used as potential market reversal areas. The VIX Oscillator is used in conjunction with VIX patterns and is especially useful during times of reduced volatility when the VIX is trending. The VIX and VXN Oscillator can be inverted in Metastock to align market highs and lows with oscillator highs and lows. 44

BullishBearish Sentiment

Sentiment Analysis Contrarian opinion is based on the premise that when the majority of people agree on anything, they are generally wrong at extremes. Based on contrary opinion, the market is considered overbought when the majority are in agreement, and is likely to run out of buyers. It is considered oversold when the majority are in agreement, and likely to run out of sellers. Sentiment Surveys help us to determine what the majority are doing, then we act in the opposite direction when price suggests to. 46

Sentiment Analysis

This type of sentiment analysis is less timely than the others discussed; however, they are powerful indicators of a probable reversal when in alignment with other internals. 47

Sentiment Analysis AAII Survey – The American Association of Individual Investors poll their membership to determine if they are bullish, bearish or neutral. Since investors tend to change their opinions more quickly, this survey tends to be more timely. www.aaii.com The survey is followed by calculating the ratio of bulls to the total, Bulls / (Bulls + Bears). Because of the more erratic movements in this survey, a 4-week MA is used of the ratio. % Bulls 70 60 50 40 30 20 10

% Bears

60 50 40 30 20 10

Bull Ratio

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2

4-Week MA

0.8 0.7 0.6 0.5 0.4 0.3 1987

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

48

Sentiment Analysis % Bulls

Historical Extremes

AAII Survey 70 60 50 40 30 20

% Bears

50 40 30

Bullish levels for % Bulls are 32% and 22%. Extreme bearish levels are 55% and 65%. Bullish levels for % Bears are 38% and 44%. Bearish levels are 20% and 14%.

20 10 0.9 0.8 0.7 0.6 0.5 0.4 0.3

Bull Ratio

4-Week MA

0.8 0.7 0.6 0.5 0.4

2002

2003

2004

Bullish levels for the Bull Ratio are .46% and .36%. Bearish levels are .70% and .80%. Bullish levels for the 4-week moving average of the Bull Ratio are .51% and .43%. Bearish levels are .70% and .78%. 49

Sentiment Analysis Investors Intelligence Survey - The survey is done by www.Chartcraftt.com and polls 130 investment news letters to determine whether they are bullish, bearish or neutral. Newsletter writers tend to change their bullish opinions more slowly to bearish than actual investors, making this indicator less timely than the AAII Survey. The survey is followed by calculating the ratio of bulls to the total, Bulls / (Bulls + Bears) % Bulls

80 70 60 50 40 30 20 70

% Bears

60 50 40 30 20 10

Bull Ratio

69

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

50

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2

Sentiment Analysis Investors Intelligence Survey

Historical Extremes 60 55

Bullish levels for % Bulls are 45 36% and 30%. Extreme bearish 40 35 levels are 52% and 58%. 50

% Bulls

30

40

% Bears

Bullish levels for % Bears are 30 42% and 52%. Bearish levels are 25 20 27% and 17%. 35

15 0.80 0.75 0.70

Bullish levels for the Bull Ratio 0.60 are .52% and .43%. Bearish 0.55 0.50 levels are .66% and .75%. 0.65

Bull Ratio 2002

2003

2004

0.45 0.40

51

Sentiment Analysis Market Vane % Bullish Survey – The Survey is done by polling the buy and sell recommendations of market advisors and commodity trading advisors relative to a particular market. These advisors change their bullish opinions more slowly to bearish than actual investors, making the timeliness of this indicator less than that of the AAII Survey. The survey is followed by viewing its raw weekly data. 90 85 80 75 70 65 60 55 50 45 40 35 30 25 20 15 1982

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

52

Sentiment Analysis Market Vane % Bullish Historical Extremes

Bullish levels for % Bullish are 35% and 25%

Bearish levels for % Bullish are 60% and 70%

53

Sentiment Analysis P

1500

S&P 500 and Signals

P P

1300

P

P

P P P

1200

O

P O

1000 900

frequent readings. Individual investors jump in and out of the market much faster.

800

O

O O

acts as an oscillator with more

1100

P

O

The AAII Bullish % Ratio

1400

4-Week MA of AAII Bullish % Ratio

0.8

The Investors Intelligence

0.7 0.6

O

Bullish % Ratio is not as fast,

0.5 0.4

but will give more frequent

0.7

signals than Market Vane.

Investors Intelligence Bullish % Ratio 0.6 0.5 0.4

Market Vane % Bullish

2001

2002

70 60 50 40 30 20 2003

2004

Market Vane Bullish % tends to change very slowly. Advisors try to stay with the trend as long as possible.

54

Sentiment Analysis S&P 500

1150

In August 2004, individual

1100 1050

O

1000 950 900

4-Week MA of AAII Bullish % Ratio

0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55 0.50 0.45

O

Investors Intelligence Bullish % Ratio 0.75 0.70 0.65

investors became excessively bearish as the S&P 500 made a new low on the year. The Investors Intelligence and the Market Vane Bullish signals are less frequent.

0.60 0.55

Market Vane % Bullish

70 65

The S&P rallied nearly 6%

60 55 50 45

from the signal.

40 35 30 M

A

M

J

J

A

S

O

N

D

2004

M

A

M

J

J

A

S

O

55

Sentiment Analysis 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80

21-Day Equity P/C

5-Day Equity P/C

Jul

Aug

Oct

Nov

0.8

0.7

0.9

0.8

1.0

Jul

1200 1190 1180 1170 1160 1150 1140 1130 1120 1110 1100 1090 1080 1070 1060

Aug

Sep

Oct

Nov

0.7

0.6

Dec

S&P 500

Jul

5-Day Total P/C

0.5

Sep

0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

21-Day Total P/C

Aug

Sep

Oct

Nov

21-Day OEX P/C

1.2 1.1 1.0 0.9

5-Day OEX P/C

Jul

Dec

NYSE VIX Oscillator

0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07

Dec 0.8 0.7

1.3

Aug

Sep

1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 Oct

Nov

Dec

Nasdaq VXN Oscillator

0.91 0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08

0.6 0.5

AAII

0.70 0.65

Investors Intelligence

0.60

Jul

Aug

Sep

Oct

Nov

Dec

Jul

Aug

Sep

Oct

Nov

Dec

By the end of November 2004, only the 21-day OEX P/C Ratio had not moved to an extreme reading.

70 65 60

Market Vane O

N

D

2004

Weekly M

A

M

J

J

A

S

O

N

D

20

55 50

While other sentiments gauges indicated risk of a correction was likely, the market moved sideways.

56

Sentiment Analysis VIX

AAII

06-19-06 VIX Oscillator Investors Intelligence

Sentiment was bearish, which is bullish! Market Vane 57

Sentiment Analysis The 06-19-06 CTOW was titled. “The Worst Is Over!”

Quote, “The expected low just might be the low for the year.” “I'm speculating on the potential for the low of the year of course, but the internals are coming into bullish alignment now. History tells us that the odds are good and that's all we can look for. It is what it is. Don't over think it.” 58

Sentiment Analysis On 4-29-07, short and intermediate breadth gauges are overbought and/or diverging. Short sentiment gauges are indicating rising risk. Long-term sentiment is still bullish.

06-19-06

S&P 500 59

Sentiment Analysis Other Sentiment Indicators Anything that acts as a barometer for suggesting that the bulls or bears have already committed themselves fully, and that a reversal is at hand because of historical extremes. Fun examples: Friends and Family Indicator – Brother-in-law and friends call you for advice to buy after 300% run; mortgaging house to plow into market; quitting day job to trade, etc. Shoe Shiner Indicator – When the lowest level professions are becoming traders and investors Media asking when Nasdaq (after historic rally over 5,000) will surpass DOW; or when they suggest total liquidation Your favorite Contrarian analyst/friend suggests buy or sell Flipping condos for a living 60

Concluding Thoughts Market Internals provide an objective comparison between the current market environment and the past based on historical extremes. Market Internal gauges should be read in combination with each other. One gauge alone may be misleading. Market Internals guide our bias – Bullish – Bearish – Neutral. This stops us from projecting our own bias that may be based on wishes, fear or greed at the moment. While price is King and what we trade. Consider Market Internals as the Queen, and as we know, the Queen often controls the King! 62

Concluding Thoughts At this point, you have the pertinent information that makes sentiment internals valuable. It’s up to you to work with the material and now make it yours, with your own trading style. With this information on sentiment internals, you don’t need to be reliant on any market analyst in order to come to your own objective conclusions about market timing. Define an opportunity where the odds are in your favor, then have the discipline to follow your trading and money management rules.

In closing, we at Pristine wish you great success! 63