A Oversold Bounce

After the last 3 weeks of downward price action, the indexes are finally experiencing a bounce. But, bulls shouldn’t get too excited just yet, as bounces like these often occur at key inflection points. Just because the market has bounced for two days in a row, doesn’t mean bulls should get excited about more upside here.

Let me tell you why…

Generally, the indexes are going to bounce after a big move lower when the following items occur at the same time:

Peak Bearish Sentiment

Peak bearish sentiment comes into play when market participants are focused primarily on fear, and it seems as though the market trading higher is a highly unlikely probability. It generally comes after several days of downward price action that just doesn’t seem to end.

Peak bearish sentiment can be seen in a variety of ways. For one, usually, traders are focused on downside targets, getting short, and continually viewing and discussing negative data. The media is generally highly focused on the downside as well, and it may seem as though the sky is falling.

For me, the easiest way to measure this is via the put/call ratio, but it’s also around the same time that traders are lamenting not being short or criticizing others for being long. Those are the easiest tells.

The chart below is of the put/call ratio on a daily basis, ranging from August 29th – September 8th. This chart demonstrates how the put/call fluctuates on a day-to-day basis. By checking the values on the right hand side of the graph, you can see where the put/call is at any given moment. A reading up above 1.0 demonstrates that market participants are incredibly bearish and there are a lot of outstanding puts. A reading below .6 demonstrates that market participants are bullish and there are a lot of outstanding calls.

As you can see, the range can fluctuate a lot, even intraday. But, it’s the average level in conjunction with how it’s moving that tells us which side traders are slanted on. In the case of the price action over the last week and a half, the put/call continued printing extreme bearish levels, followed by likely short-covering in the mornings, in which traders would either take profits or get long again.

The primary indication that the market was ready to bottom (just in the short-term) was how many days the put/call was up above .95. There were just too many traders short.


Key Support Zones

More often than not, peak sentiment occurs near a key and pivotal support zone. In this case, it was 3900 in the S&P futures, and 12,000 in the Nasdaq futures. Check out the chart below of the S&P futures from September 7th, 2022.


Now, as you can see from my charts, 3900 isn’t the only area of support. In fact, I have support going down to 3761. Which, is a pretty wide range. But, the key psychological values and big round numbers are typically the ones, especially in the core indexes, that hold. At least, initially. It doesn’t mean they will hold forever!

Oversold Volume

There are many ways to measure volume, but I personally like the Volume Zone Oscillator in ThinkorSwim. I also have an updated, premium version that I use called the Turbo VZO, which you can find on my charts at the very bottom. This graph demonstrates how volume is flowing. Volume can peak at either end of the spectrum. For example, if volume is incredibly oversold, it usually can’t keep getting even more oversold.

Check out this chart of the Sector SPDR Consumer Staples ETF in which I highlight peaking bearish volume at the bottom of the graph.


Volume hit peak bearishness three times on this graph, and so far, 2/3 times was a tradeable low. Now, notice how I say ‘tradeable low,’ and not, ‘The Low.’ It doesn’t mean it’s the low forever, it means it’s the low for now. How long that low lasts depends on how price behaves on the way up. It depends if it’s able to break through resistance, or not. It depends if buyers come in with a vengeance, or not. Price can just as easily rally directly into resistance and fail again, but it’s still a tradeable low.

As for the low on 9/5, as of right now it’s a peak low but I highly doubt this low will hold for long, personally.

Even though these three factors have come together to demonstrate a tradeable low/peak bearish sentiment, it’s September, and overall, the market is very weak. So, while this low may be good for 1-2 days of upside trade, *maybe* more, I wouldn’t count on it for long.

That means traders need to watch overhead resistance zones for failures on the way up. 4000 in the S&P and 12,500 in the Nasdaq are two key and pivotal levels I am watching as major resistance.

So, what is a trader to do?

Be aware of signs of peak bearishness, especially if you’re short. It provides a great timeframe to take profits (and avoid getting short at the lows). If you want to get short, shorting into the tradeable bounce is usually the best way to do it! Don’t get short at the lows!

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