February 15, 2011 By Kenny

Today we have a special guest blogger, Price Headley of Big Trends. Price is a Traders Hall of Fame inductee and is a regular contributor on CNBC, Fox News and Bloomberg Television, and in a variety of print and online financial news outlets. Today Price will share some of his insight on a few indicators he looks for to signal a possible market reversal. Be sure to comment with your thoughts and check out Prices’ new Coaching Kit at BigTrends .

In our 20 years plus of option trading and educating investors, there are certain factors that we’ve seen time and again can help foretell when the market is on the verge of a trend momentum switch.  As part of our complimentary Coaching Kit, we are highlighting how to pinpoint market reversals – part of the Coaching Kit includes a comprehensive Market Timing course that you can use to build on today’s article.

Beyond our innovative technical analysis indicators, we also utilize sentiment and volatility based measures that can often give us the “early warning” that something may be amiss in the markets.

The first of these is the CBOE Volatility Index (VIX), which I’ve been analyzing and utilizing since the early 1990s.  The VIX measures in the implied volatility of S&P 500 Index (SPX) options — this is a factor that is basically human-controlled and has swings based on supply and demand for options.  To a large measure, it measures the “fear factor” in the market among option traders.

In recent years, VIX movements higher have tended to indicate that something is not quite right in the stock market and that large-scale selling may be imminent.  For example, take a look at the following chart of the VIX and SPX from 2010:

VIX & SPX Daily Chart with Bollinger Band

In the above chart, you can see that the VIX (green) moved above its Top Bollinger Band (aqua bands) in April, before the market topped out.  There was even another early warning about a week earlier where the VIX breached its Top Band but closed below it!  Another bigger seismic move in the VIX followed at the beginning of May.  The result:  the stock market (SPX in yellow) dropped nearly 20% in the two months following this VIX move!

There are two other sentiment & volatility measures that we utilize to find the big market trends early on.  One of these is Put/Call Ratios.  These measure the trading (mostly among the public) of option puts and calls.  We’ve designed unique indicators to track both the CBOE Equity-Only Put/Call Ratio and the ISE Inverse Call/Put Ratio.  We will often see a suspicious spike in these measures before the market makes a big move — and on the inverse, there are times when these become contrarian indicators and tell us that the current trend will continue!  Much more is available on this in the coaching kit.

Finally, a third broad-based measure we utilize to determine whether a market trend shift is imminent or will continue and/or strengthen — let’s call this sentiment, media & surveys.  This is more of a contrarian (going against the prevailing wisdom) indicator in many cases — we’ve seen countless examples of mass media panic at times of huge market bottoms and “buy stocks now” type articles when a bearish trend occurs, for example.  Remember how many articles there were about “easy money in real estate” right before the bottom dropped out of that market?  We’ve seen that time and again and recognize when bubbles will burst.

Even “fading” (going against) some of the online touts such as Jim Cramer can be utilized by the knowledgeable trader.  And we know how to trade the reaction to news events, which is MORE important usually than the news event itself.  Another example is investor sentiment surveys, such as the prominent one by Investor’s Intelligence.  This measure of bulls/bears will often provide very good short-term contrarian signals for the markets when it reaches extremes.

Keep an eye on the VIX, Put/Call Ratios, and Media Sentiment/Investor Surveys and you can often see whether the current market trend is due for a huge imminent reversal or whether you can ride the trend higher for further profits.  For more in depth instruction on the tools and methods that I use check out our free BigTrends Coaching Kit available here .