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IN AN EMOTIONAL MARKET, LET SENTIMENT BE YOUR GUIDE

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If the stock market were a mental health patient, it would have been committed by now.  Major trend changes are occurring at points of wild volatility and extreme fear.  I've written many times in the past about my favorite sentiment indicator - the equity only put call ratio (EOPCR).  I take a different approach in measuring relative complacency and fear by using short-term and long-term moving averages of the EOPCR and expressing that difference using the PPO oscillator (thanks Chip!).  When the market sells off with the velocity it displayed recently, multiple technical support levels are wiped out without hesitation.  Market makers go on "vacation" as I like to call it.  It's as if technical indicators are meaningless.  Enter sentiment indicators.
 
It makes complete sense to me that when you're dealing with a wildly emotional market, that the only reliable type of indicator to predict a market reversal would be sentiment-based.  Therefore, I always urge our members to follow the relative pessimism levels and only consider acting when the market reaches pre-determined relative fear levels (-20% on the chart below).
 
In my last article, I mentioned that I'd be looking for relative pessimism to mark the next bottom.  Take a look at how it did exactly that:

EOPCR 8.20.11

Please note that the above chart was as of Wednesday's close.  It would need to be updated for the activity on Thursday and Friday.  Also, intraday charts using this ratio can be misleading, so make sure you look at this AFTER the market closes.
 
On Tuesday, August 23rd, I will be hosting the next in our Online Trader Series.  These events are highly educational and designed to equip our members with the knowledge necessary to trade the stock market with success.  The upcoming event, "The Effect of Market Makers on Trading", will provide a background of the role of market makers and delve into the relative pessimism ratio of the EOPCR.  Market makers exacerbate the emotional swings in the stock market.  If you want to use this information to better your trading strategy and success, you can register for this event by clicking here.
 
Happy trading!

Tom Bowley
About the author: is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market. Learn More
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