Time to buy?

[Luvnrio]

Thanks Aiki...

Barrons:

Whiplashed? That's a Bullish Sign
Now Is the Time to Buy, Not Sell
By RICHARD W. ARMS

UP 400! DOWN 300! UP 260! TO many stock-market observers, especially those accustomed to the minimal price volatility of recent years, such dizzying swings in the Dow Jones Industrial Average might suggest stocks have lost their moorings and are headed sharply lower. History says otherwise, however, as huge volatility is associated with market bottoms, not tops. When volatility spikes to the levels seen recently -- levels that have prompted even the nightly news anchors to wag their heads in disbelief -- it is usually time to buy, not sell.

Just how volatile is today's Dow? An elementary way to measure volatility is to calculate the daily percentage change, either positive or negative, in the price of the DJIA, using a moving average of this change to smooth the data. I used a 10-day moving average, which I called the Absolute Percentage Change indicator, or APC, and graphed the results since 2000, comparing them to a chart of the Dow over the same period. Then, to check the validity of my results, I charted the APC since 1940.

The peaks and troughs in all my charts tell an interesting story: Huge volatility isn't unique to today's market, and often occurs just ahead of a substantial rally.

The APC currently is at a five-year high of 1.63. Investors haven't been so apprehensive since driving it to 1.70 in March 2003, just before the start of the five-year bull run. Yet, while the Dow's recent moves may seem extreme because of the size of the numbers, the indicator hasn't come close in the past 18 years to matching its October 1987 peak of 7.08 (meaning the Dow swung more than 7% a day, on average, over a 10-day period). This, too, occurred as stocks reached a bottom.

Generally, any time the APC moves to the neighborhood of 1.5% it is time to start buying. In bear markets, the indicator tends to reach an extreme above 2%, while in bull markets a move above 1% usually is a rare and timely buy signal.

The APC is less useful as a tool to spot impending sell-offs because overbought markets tend to roll over more slowly. However, any reading below 0.5% reflects extreme investor complacency, and a warning of a likely pullback.

Why is greater volatility a sign of brighter days? When stocks rise or have risen, investors usually get complacent. But when prices are falling, each down day amplifies fears, leading to violent price swings. Maximum panic occurs at the bottom.

Today's high volatility suggests we're in a bear market. Something important happened at the end of July to bring about the change. Yet a good rally wouldn't mean stocks are entering a new bull market. We'd need to see declining volatility, and the return of complacency, to say the down move that began last summer is over.

The Arms Index, which I unveiled in Barron's 40 years ago, compares advancing and declining shares to advancing and declining market volume, to see if advancing stocks are getting more volume. A lower reading is evident at market tops, and a higher one at the lows. The intermediate- and long-term moving averages currently support the APC's bullish signal, though the short-term Arms is neutral. This suggests any rally could hesitate in the near term, but is likely to have legs.

Just as the Arms Index deduces enthusiasm for advancing issues, the Average Percentage Change, a simpler calculation, gives us a way to measure the level of fear in the market, and tells us when buying or selling have been overdone.

Astute traders should take advantage of extremes by going against the crowd.

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[Leth]

nice post...very informative