Standard Deviation Analysis

The premise here is simple. When either the +3sd band or negative -3Sd bands are hit; it suggests that an oversold or overbought condition is in the works.  Example if the market is topping and the +3SD band has been hit each time then it would indicate that there is a pretty good chance of rather sharp downward move occurring and vice versa.  If we are in an up trend, meaning that the +3Sd band was hit and the markets have pulled back. A test and the ability to hold above the 18 or 30 day moving average would indicate that the markets will most likely rally to test the +3Sd bands again.  This tool should be used in conjunction with 2-3 other TA tools or simple trend analysis.  One should never make a judgement based on this tool alone or any other individual tool; always use 2-3 tools. The more TA tools use familiarize yourself with the better. However one should not exceed 6 tools as you will most likely overwhelm yourself. Ideally 3-5 tools should suffice.

Standard Deviation	Dow	NASDAQ
+3Sd	14493	2826
+2Sd	14221	2768
18 day SD moving average	13679	2650
-2Sd	13136	2532
-3Sd	12896	2473

Difference between -3Sd and +3Sd bands

(15 weeks worth of data provided below; updated on a weekly basis)

Highest value between the -3Sd and +3Sd band for Dow = 1619 (March 13, 2007)

Highest value between the -3Sd and +3Sd for NASDAQ= 397 (March, 13, 2007)

This is what we had to say last week and to some degree it has come true.

Okay the markets surged as expected and the bands snapped wide open now the markets still need to mount some sort of correction and we expect them to mount a mediocre correction to the -3Sd bands which now sit roughly in the 13109 ranges.  Market update July 24t^h, 2007

The SD bands have expanded yet another 300 points on the Dow and roughly over 140 points on the NASDAQ; the bands are now just walking distance from the all time high put in March 13, 2007 (1619 on the Dow and 397 on the NASDAQ). 

Market Commentary

The SD bands are now just a few points away from taking out the high put in March of this year.  When the band expand so rapidly it usually leads to a strong upward move; this move can take anywhere from 3 weeks to as long as 21 weeks to materialize.   Based on the many bullish factors we have listed in the last few weeks we feel that this move up will take place sooner then later.  In addition we stated that the markets would experience a mediocre pull back that would take them to -3Sd level of 13109 (last week’s value); we are almost there as the Dow has so far traded down to 13134.

The moving average of new lows also continues to lead all the moving averages of new highs and ideally we should get one more washout day where at least the 20 day moving average of new lows surpasses the 2550 mark.  

NYSE short interest has put in yet a new record high and it’s almost impossible to witness a bear market with such a high short interest ratio; if it were to happen it would be one for the history books.

Note the main culprits driving the market down are not new factors; in fact this news is old news.  Thus it surprises us that the jackasses or experts as most people fondly refer to them are all clamouring taking about the massive fall out from the sub prime sector, higher energy prices, inflation and so on. If this was something new we would agree but these problems were around before the Dow put in a new high and despite all these problems the market still rose to new highs.   Not one of these chaps can come out and state that this market was in sore need of a correction and that the current correction is something good for the markets as it going to cleanse out all the excess garbage and allow it to build force for the next leg up.  We suspect something so simple is beyond such brain surgeons; on second thoughts if they were to come out and state this we would have to be more cautious as the masses are always wrong.  Perhaps we should be happy with their observations and deductions.   Though as of late a few individuals have come out and stated that its time to buy; thus it will probably take a bit more sideways action before the markets are ready to move up again. 

Incredibly we had two selling climaxes last week on Tuesday and Thursday, where the Down volume was over 90% ( 93% and 94%) and we came very close to having a third one but the Down volume just missed by 2 percentage points.  All in all we have had 3 selling climaxes in less then 3 weeks and we view this as a rather bullish development from the intermediate time frames (6-15 months).  

The Dow experienced its worst week in over 5 years last week when it lost close to 600 points; again this was long over due so at least for now there is no reason to panic.  On Thursday when the market was down over 300 points some experts started talking about a repeat of black Monday and normally coupled with the 3 selling climaxes this market has gone through we would have said that the time to buy was very close at hand. However as stated earlier some individuals actually started coming out and stating that it was a very good time to start buying. Thus we feel that the markets will trade sideways for sometime or drop a bit further before putting in a base. We feel that most likely the next leg up will begin towards the end of summer and that during this base building stage individuals should be looking to add to or open up new positions in many of the plays in our portfolios. Advanced traders can also look for stocks that are holding up the best or putting in base formations earlier as these chaps will rally the strongest when the markets begin to move up.

Here are several reasons why believe that a bear market is unlikely at this point in the game:

1)     Short Sales by NYSE specialists have once again reached record low levels

2)     NYSE short interest at record levels

3)     No Major sell signals on any of our indicators; psychological and technical

4)     Program traders who now accounts for over 50% of the trading volume have opened up massive short positions and they will need to cover these positions eventually which will generate a surge in buying power. Remember the only way to make money from a short position is to actually close it out and eventually every short position has to be closed out if the individual wants to bank a profit.

5)     Institutional investors unloaded billions of dollars worth of stock; they were selling into strength; we mentioned this in the last few updates. For them a 10% gain is a big deal as they are dealing in billions of dollars. Now that the markets have pulled back they are going to be looking for sectors to redeploy this money.

6)     If you look at the number of odd lot shares being purchased it shows that the small investor is still sitting on the sidelines. The small investor for the most part has missed this entire leg up and sooner or later they are going to feel that the markets are the only place to make some money now that the housing sector is dead.  These small investors collectively have a huge amount of money that has been sitting down and doing nothing now for quite sometime. When they decide to commit this money it’s going to provide quite an upward thrust to these markets.

7)     Short selling on the NASDAQ has also reached record levels and now stands at 1.8%; it would now take over 4.9 days to close out all these short positions.

8)     The ULPIX to URPIX ratio (ultra bull profound and Ultra bear fund) reveals some rather interesting data

This chart indicates that the dumb money is actually still shorting the markets quite aggressively and this ratio is now approaching the bullish zone.  The ratio now is at the same level it was before the markets embarked on this huge move up which began around March.

As we stated last week there are several negatives but one of them stands out quite a bit and that is the huge levels of margin debt.  At some point in time this is going to be a problem and will result in the markets pulling back even more but it’s still not at extreme levels and such bull markets always end when everything is at an extreme point.  Unless there is a major catastrophe the Dow will be trading at the 20,000 mark in the years to come.

Finally we decided to conduct a rather in-depth and tiresome analysis of the Dow 30 stocks. Let’s see what they reveal.

Analysis of the components of the Dow 30