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This Indicator’s Out of Character

Keep a close eye on the VIX put/call ratio – it’s just not acting itself lately – and, be aware that this correction might not be over yet.

The Market

There were a few positive developments in the market on Thursday and Friday. The main ones: The number of stocks making new lows began to contract and we saw some fear come back into the market.

The 10-day moving average of the new lows on both the NYSE and Nasdaq stopped going up on Friday. I consider that a plus. Some might say it’s just the math, because 10 days ago there were over 100 new lows on Nasdaq, and now there are 84, which is still high.

But at least for two days this metric showed something positive.

For the New York Stock Exchange, Friday saw 36 new lows. We have not seen so few lows since Nov. 6, right around the time the majority of stocks started heading lower. Sure, some of them are in the energy space and if energy turns south again the new lows will pick up again, but there has been a change.

Then there is sentiment. I’m not sure overall sentiment has changed drastically, but for three days last week the put/call ratio was over 100%, which is a change. The equity put/call ratio remains in the 50s and the 10-day moving average is not high enough to comment on, but at least folks were buying puts as opposed to calls.

Now comes the hard part. In the last week the put/call ratio for the Volatility Index has soared. There were three readings over 100%. Let me stop here and review this metric, since it takes some thinking to get our heads around it.

This is the VIX we’re talking about, so a high put/call ratio means folks are betting on a lower VIX. That generally means a higher move in stocks.

Typically a one day reading tells us too many are too bearish the VIX and bullish stocks. It is contrarian. The first such high reading came on Tuesday, and, shockingly, the very next day the market headed south. Oh, I know it wasn’t much, but it was the worst day for stocks in a month. Thursday and Friday saw the same type of high readings for this indicator. I have gone back over the last several years and have used various moving averages to determine if there is anything to note. The curious part is that the prior instances when the 21-day moving average has soared, this high has come amid periods of high volatility. So, yes, the persistence in buying VIX puts was right, but they were doing so when the VIX was in the 20s – not at 12 as it is now.

The chart of the 21-day moving average of the VIX put/call ratio (red) with the S&P (blue) from 2014 to 2016 shows five such peaks. But take a look, Point A was a 100 point plunge in the S&P. Point B was a similar 100 point plunge. Point C arrived in the midst of the August to October 2015 plunge of nearly 300 S&P points.

Points D and E came in May and June of 2016. In May we didn’t exactly plunge; we had a 2%-3% decline, but it was enough that it lasted several weeks and we can see it on the chart. Finally Point E was the Brexit plunge and recapture.

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Mid-year 2016 saw those two high readings in May and June, but they saw another one in late July and early August. That is the closest time I can find where the market wasn’t terribly volatile and the VIX options players were betting on relative quiet. That’s the green arrow on the chart. There was a subsequent decline of about 100 S&P points but it took two months to get there.

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Now let’s look at the VIX from 2016. Here you can see the May and June peaks in the VIX (blue arrows) and understand why folks might be on volatility easing off. The green arrow is that late July and early August time frame which is when the VIX was at 12, similar to now.

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We are oversold enough to rally this week, but I am not convinced that the correction is over. And when an indicator like this VIX put/call ratio does something so out of character it’s a good idea to stay on our toes.

New Ideas

I don’t know if this is the environment for a stock like Southern Copper (SCCO) - Get Free Report to make a run, but if it can get up and over this line of around $38, it probably gets stopped at the old high and then is a buy on a pullback to the line. A move back under $37 and I’d give up on it.

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Johnson & Johnson (JNJ) - Get Free Report had quite a move last week, but more so, it made a higher high beyond that prior spike high. It has resistance starting here at $138 on up now, so I would not chase. I might even take profits on some of it, because that little base only measured to $138. But I would like to buy it back on a trip back to the line of about $134 to $135, if we get one.

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Today’s Indicator

The chart of the 10-day moving average is below:

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Q&A/Reader’s Feedback

Helene welcomes your questions about Top Stocks and her charting strategy and techniques. Please send an email directly to Helene with your questions. However, please remember that TheStreet.com Top Stocks is not intended to provide personalized investment advice. Email Helene here.

I recommended Alcoa (AA) - Get Free Report back a few months back and it has been quite disappointing, but it is still interesting as long as it stays over this $20 area. If it can ever get over $23, it would be even better.

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I was asked if (MMM) - Get Free Report is basing, and it certainly is trying to. As long as it stays over that lower line it’s got a chance to improve. I wouldn’t argue against it. I might even argue for it.

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A few months ago I recommended Steel Dynamics (STLD:Nasdaq) and was asked for a measured target on it. It had a terrific run in September and then gave back almost all of that run and has crawled its way back to resistance. If this stock can get over $33, then I think it eventually makes its way back to that old high from February in the upper $30s.

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