Rydex Traders Throw In The Towel

Regular readers will remember that in late January I pointed out that based on the trading activity within the Rydex leveraged ETFs, there was a market top in sight. A few weeks later in February it did indeed arrive.

Then again in early May I pointed once more to the same indicator and suggested that we were about to see have another market top. This time the market reached a peak immediately.

In the light of those two prescient warnings, the market weakness we’ve experienced is understandable. The S&P 500 index is down more than 7.5% from its peak and the Nasdaq Composite has retraced more than 9%.

So what is this accurate indicator telling us now?

Instead of showing you the raw Rydex Leveraged ETF ratio as before, I thought we’d instead look at the 100 day stochastic of the ratio. This simply takes the ratio and converts it into a range bound indicator with a maximum of 100 and a minimum of 0.

As you can see from the chart, the indicator is now almost back down to its lower extremes. Earlier this week the lowest it reached was 24. That is still a bit away from the lows it reached last summer but it is enough to warrant lightening any short positions.

Other measures of Rydex trading activity show even more positive bias. For example, if we look at the various Rydex sector mutual funds, we see that less than 10% of them have current assets higher than their 50 day moving average. This means that Rydex traders are exiting almost all sectors en masse. Historically when we’ve seen this level of reluctance to hold Rydex sector funds, a major low wasn’t too far away.

Another measure of Rydex activity focuses on the flow of funds into bullish mutual funds, both leveraged and non-leveraged funds. The pattern in this indicator is also bullish because Rydex traders are seriously paring their long exposure to equities.

By itself this or any other indicator is not to be trusted. But taken in concert with the other signs that we’ve seeing, including the option trading activity, this important contrarian indicator based on Rydex trading activity suggest that the market is about to find support at these levels.

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3 Responses to Rydex Traders Throw In The Towel

  1. volar says:

    Again, Nice work!

  2. Ted says:

    The fact that the market has hit numerous sentiment extremes all while the S&P is trading above its 200 day moving average is quite shocking. I looked at 2003 to 2007 and couldn’t find a single instance where people were buying this many puts for so long while the market trading above the 200 MA.

    I think this supports the notion that not only is the bull market alive, but we’re far from a top. In fact, the 3500 NDX target is seeming more reasonable now that everybody takes a 7 or 8% correction as the sign of Armageddon. Now the 200 MA might be taken out next week, but gee, everyone is acting like it’s already been blown out.

  3. Tiho says:

    I agree with Ted.

    The options market is insanely pessimistic. Bloomberg note showed that there had been 11 other occasions when the put/call ratio exceeded 1 and at the same time the S&P 500 was trading above a rising 200-day moving average. In all the circumstances, the market posted gains in the next 12 months, with returns averaging 11 percent.

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