Have Stocks Hit Bottom?

Eight straight days of major losses, followed by a superlative 11% to 12% spike in stocks, to open the week. The buying was expected, given the extremely technically oversold condition in stocks that were begging for buyers to come in, albeit the scope of the one-day rally was not.

The problem was that the buying enthusiasm was not sustainable, as markets reverted back to the recently familiar loss column on Tuesday in a day filled with intraday volatility. The profit-taking on Tuesday was expected. However, you should watch over the next few sessions or weeks to see if a near-term bottom was formed last week, when the DOW broke below 8,000 and the NASDAQ at 1,800.

While I expect to see intraday volatility continue given the market uncertainties, the key will be whether stocks hold at the recent bottom following the selling capitulation. If a bottom is in play, you can trade stocks in a range based on the intraday volatilities.

What I like to look at is the option volatility readings from the CBOE as a contrarian indicator of how the market will trade. Option volatility indices represent a near-term market volatility based on NASDAQ 100 index option prices. An upward trending volatility reading indicates maximum fear and a possible market bottom, while a declining volatility reading indicates reduced apprehension and a possible market top.

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What we are currently seeing in the stock markets are rising readings suggesting a near-term bottom for stocks. The five-day CBOE NASDAQ Volatility Index (VXN) has been rising, an indication of a near-term bottom on the NASDAQ. The five-day CBOE S&P 500 Volatility Index (VIX), a barometer of near-term market volatility based on the S&P 500 index option prices, has also been on the rise in recent weeks.

The reality is that the recent decline of the DOW to below 8,000 and the subsequent bounce to above 9,000 on Monday may indicate a near-term bottom, but only time will tell if this is true.