Sonar Trio Signals Potential Bottom

03/29/11 08:20:28 AM

by Matt Blackman

As stocks gain momentum, traders are wondering whether the bottom is in. Here is a set of indicators to help you decide.

Security: NYSE
Position: N/A

Few traders would argue that despite its obvious risks, bottom-picking remains a popular pastime for both traders and active investors. Here are a set of indicators to help give perspective and reduce the risk of trying to catch a falling knife prematurely. I call it the "sonar trio bottom sounder" (STBS).

FIGURE 1: NYSE, DAILY. Here's the index with three indicators: NYSE new highs - new lows (red), the NYSE put/call ratio (green), and the Williams VIX FIX indicator (blue).

Graphic provided by: www.GenesisFT.com.

In Figure 1, before the latest signal (vertical dashed red line far right), the STBS fired twice in the last nine months. A signal is generated when new highs - new lows (NH-NL) hits a medium-term low, the put/call ratio (PCRN) hits a medium-term high and the Williams VIX FIX 10-day weighted moving average (WMA) rolls off a medium-term high. For those not familiar with the Williams VIX FIX, it was developed by trader Larry Williams to give a synthetic volatility or VIX readings for an issue.

There are no automatic trigger levels for each of the three components, so the signal must be drawn at the discretion of the trader.

Signal 1 fired in August 2010 (far left vertical red dashed line) when the NH-NL read -58 and the PCRN read 114. The VIX FIX had topped, although the 10-day weighted moving average was still rising, which showed that volatility was nearing a peak. This marked a very good entry point after which the NYSE surged 18% over the next three months.

At signal 2 (November 23, 2010), the index was still falling but after bottoming at -126 the week before, the NH-NL was moving higher and the PCRN had put in a lower high of 90.34. In addition, note the positive divergence, which although not common, is a good indicator that the worst is over for an issue.

The latest signal fired March 16 following a low of -51 for the NH-NL the previous day, a spike in the PCRN of 129.75 and a top in the VIX FIX 10-day WMA. The VIX FIX had already peaked and was dropping.

Until I discover the holy grail of bottom picking, the sonar trio will have to serve me in helping take bottom readings and assist in making more objective readings at potential bottoms. Trendlines are a very valuable confirmation tool and also assist the trader place tight stops in case of an unexpected reversal.

If the NYSE Index fails to decisively break the upsloping blue dashed trendline in Figure 1, it is best to keep your powder dry while you wait for a better signal.

I will be discussing the sonar trio bottom sounder in greater detail complete with generic formulas for each of the three indicator components in an upcoming Working Money article.

Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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