Short Anatomy of a Sell-OffJanuary 31, 2020
Sell-offs can start for any number of endogenous or exogenous events. A mentor used to tell me, “There are a million reasons to sell a stock, but one reason to buy.” What he meant was that there are always personal reasons to sell: tuition is due, you aren’t sleeping due to risk in markets, you need buy a new car, etc. The only reason to buy a stock is if you think it is going up.
So, we’ll proceed from the standpoint that a sell-off is getting going and ignore some post-casting of the causes.
Let’s start with looking inside the stock market itself for some clues where we are and how far we may have to go. There are so many simple, useless indicators that I won’t bother showing moving averages, highs/lows, etc. I’ll assume most have access to this data. I’d like to try to add some value by displaying some charts we use at our firm to gauge sell-offs.
Let’s start with looking at how lopsided volume in the market has been recently. For this we use the percent of volume rising and falling on the NYSE. As of this writing on Friday morning, about 85% of volume on the NYSE is down volume. This is elevated but not quite to the 95% rate we see at lows.
Next, let’s look at volatility. We like to look at the term structure of volatility. Generally in sell-offs, spot volatility rises above 3-month or 6-month volatility by 10+ points. Spot volatility is slightly above longer dated volatility futures, but not by much.
We look for serious inversions on this indicator to indicate an exhaustion in selling pressure. We’re not even close on this one.
How much are traders hedging? This is pretty easy to identify looking at the CBOE put/call ratio which measures the number of calls bought relative to the number of puts. When the market is fearful, the put/call ratio surges above 1. The last reading here is 0.61, indicating more room for traders to get fearful.
The Trading Index, also known as the TRIN, measures advancing vs. declining stocks relative to advancing vs. declining volume. In a good sell-off, we see this ratio exceed 3.0. At 1.87, we’re moving higher, but not very close to extreme readings of the past.
If this sell-off progresses and turns into a 5% correction, we’ll be watching these indicators to identify whether a buying window appears.