Trading the Panic

Preface: Explaining our market timing models 

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.


The Trend Asset Allocation Model is an asset allocation model that applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can bsoe found here.



My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities
  • Trend Model signal: Neutral
  • Trading model: Bullish

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real-time here.


Fear rising

The stock market action last week is an example of a classic panic. Not only is the market oversold, but also extreme fear is showing up in sentiment readings. The weekly AAII survey has flashed a contrarian buy signal for a second consecutive week. Not only is the bull-bear spread at an extreme seen only two other times in the last 10 years, but also bearish sentiment is the fourth highest on record in the same period.



While survey-based sentiment models can be useful, they can have only limited utility because the surveys ask respondents their opinions and not what they are actually doing with their money. Option market sentiment, which is based on actual fund flows, is also showing signs of high anxiety. The term structure of the VIX inverted last week, indicating high levels of fear.



The Bollinger Band of the VIX Index also spiked above 90. Past episodes have marked either bottoms or preceded short-term bottoms.



As well, SentimenTrader observed that small trader put option buying is off the charts, which is contrarian bullish.




An oversold extreme

The market is oversold, but you probably already knew that. The Zweig Breadth Thrust Indicator fell to an oversold level last week. As a reminder, a ZBT buy signal requires the ZBT Indicator to rise from an oversold to overbought condition within 10 trading days. ZBT buy signals are rare. There was only one buy signal in the last five years and three in the last 10 years. By contrast, there were 13 ZBT oversold conditions in the last five years and 29 in the last 10 years. Virtually all ZBT oversold conditions resolved in short-term rallies.




Constructive breadth

Even breadth indicators are becoming more constructive. Net NYSE and NASDAQ 52-week highs-lows bottomed out last Monday and turned less negative.



Similarly, the relative performance of the equal-weighted S&P 500 to the S&P 500 is turning up. The average stock in the index is outperforming the index itself, which is another sign of breadth improvement.




Insiders are buying

Another data point supportive of a bottom is the appearance of insider buying. The latest reports show that insider buys are outnumbering insider sells, which is a positive development by this group of “smart investors”.



However, insiders are not perfect at timing market bottoms. However, a cluster of persistent insider buying is a signal that a durable bottom is forming. As an example, consider the insider trading pattern during the Great Financial Crisis.



Insiders also stepped up to buy in 2011 at the height of the Greek Crisis.



Insiders were equally timely in their purchases during the COVID Crash of 2020.


While the latest whiff of insider buying is constructive, they cannot be regarded as a full fledged buy signal until buying becomes more persistent.



Echoes of 2008

This level of daily market volatility is almost unprecedented. Bloomberg reported that the only parallel is October 2008.

Twice in two days, S&P 500 has erased a gains of roughly 2% to close the session lower. Such a streak of big back-to-back downside reversals has occurred only once before in Bloomberg’s four decades’ worth of data: October 2008. Equally big swings rocked the market on Monday and Tuesday.

Consider the differences between then and now from the viewpoint of my bottom spotting model. Currently, three of the four components of the model have flashed buy signals. The only missing element is the lack of a TRIN spike indicating price-insensitive margin clerk selling.



Here are the readings from October 2008. The S&P 500 was experiencing extreme levels of daily volatility. In early October, the VIX Index rose above its upper Bollinger Band and recycled, just as it did now. The term structure of the VIX was deeply inverted starting in mid-September and the high fear level lasted until December, which is different from today. The NYSE McClellan Oscillator reached an oversold condition, just like today. TRIN experienced several spikes above 2, which are indicative of price-insensitive margin clerk liquidation, which has not happened today.



The key difference is the macro backdrop. The financial system was undergoing an institutional bank run. The stability of the global financial system was at risk. The banking system was at the edge of an Apocalyptic cliff.


Fast forward to 2021, the Fed has signaled a regime shift from an easy monetary policy to a tightening policy. Further, the markets are rocked by fears of a Russia-Ukraine military conflict. These are the same scale of Apocalyptic fears that the markets faced in 2008. At worse, today’s events represent normal equity risk, which should resolve in a 10-15% pullback.


In conclusion, the US equity market is undergoing the classic signs of a panic bottom and it is poised for a relief rally. While it’s difficult to pinpoint the exact point of a bottom and Friday’s one-day strength does not make a trend, the ability of the S&P 500 to hold above support on the 30 minute chart is constructive.




Disclosure: Long SPXL


17 thoughts on “Trading the Panic

  1. Cam – My turn to ask for further clarification on your closing comments.

    ‘At worse, today’s events represent normal equity risk, which should resolve in a 10-15% pullback.’

    A 10-15% pullback from the January highs? Or from current levels? In other words, is your base case scenario that we’ve already seen the worst and if markets were to sell off further the decline would (hopefully) be capped at another -5%?

  2. The flaw, if any, in the ‘Buy the panic’ strategy is time. The market peaked just a month ago. Previous ‘Buy the panic’ successful opportunities evolved after many months of panic, not one.

    Here is a chart of Fed Funds futures. During the month of January, it added two quarter point rate hikes (green line) to the December 2022 contract. That is a HUGE negative for stocks. The last chart above showing strong support, in the last week, is amazing given the weight of this ‘Wealth Effect’ negative. My guess is that the support gives way to great investor shock, rather than it proves to be a dam holding back the rising water.

    I’m glad to see the stat on margin debt (TRIN). The Robinhood/ARKK/Reddit crowd are getting killed on their margin. Only a small amount of shares of ARKK have been redeemed. They have had ‘diamond hands’ so far but how long can they go? TRIN might be the best low marker.

    Everyone should read Jeremy Grantham’s article on the coming crash just to understand the bears argument. Unwinding three bubbles without carnage will be an amazing feat by Central Bankers.

  3. Great quote from John Mauldin this week;

    The old and often-maligned, “It’s different this time,” is undeniably correct, too. We have never in market history seen anything comparable to the last two years. The virus itself, the fiscal and monetary policies it provoked, the market response to those policies… none of it has been remotely “normal.” We can’t rely on precedent when everything is unprecedented.

  4. It occurred to me yesterday that there is a widely held belief….that the Fed with QE and low rates is the reason that people felt forced out on the risk curve and so prices went higher and higher…TINA…geez I believe it.
    So the converse that tightening and raising rates will cause a crash. Is that true? Will we sell and run out to buy bonds for that extra little bit? Maybe a lot of people are positioned wrong on account of that belief because the first one is held by the vast majority….it’s like in a scary movie. We just might get a ZBT for that reason.
    1998 LTCM rates tanked, but then they went up until the nasdaq top…if we get a monster rally we should not have to wait long, but the wait might be tough….Mr Mackie says “margin is bad m’kay”

  5. S&P is at 200 dma resistance. We should soon know if the market gets above it convincingly. I also think a retest of last weeks low is likely – May be on the sounds of cannon.
    There is no accepted definition of a ‘bubble’ – if there is, I have certainly missed it.
    The economy is strong, supply side issues will get better(many countries are already treating Covid as something to live with. China is an exception right now due to Olympics.). Inflation itself acts as a drag on inflation due to demand destruction. Interest rates will further provide brakes on demand. So, in coming months, inflation should moderate. Atlanta GDPnow is very soft.
    I am cautious but not scared. It’s not 2000 or 2008 macro backdrop.

    1. I think a bubble is an after it pops phenomenon…if it doesn’t pop. it’s not a bubble yet. What happens when things go beyond 3 standard deviations? It becomes more at risk of a correction, but if it corrects and then keeps going up, it’s not a bubble. My impression is that we are in a bubble, or what will at some future point be called a bubble. Bitcoin could have been referred to as a bubble many times on it’s rise from pennies per coin, look at NVDA how it has gone up over the last 10 years, is it in a bubble? So I think this bubble terminology is an after the fact name, like someone driving recklessly crashes and then you have a crash and everyone wants to slow down and rubberneck.
      I wonder how China can do it’s lockdowns on covid outbreaks with the olympics…glad it’s not my headache

      1. I generally agree that bubbles are called bubbles in hindsight. Bitcoin with no intrinsic value is this era’s tulips, but NVDA is a highly profitable company that opened new markets over the last decade and last year raised prices 83% and got away with it. One of these things is not like the other.

        I think we are seeing some air let out of those areas that need air let out. This is healthy!

        1. my point is that had NVDA crashed it would have been called a bubble. I would add that a single stock is not like an index or a sector, so bubble maybe does not apply as well. With commodities they say boom and bust, same pain, another name.
          Take copper as an example. New large scale deposits are rare, grades of ore are going down, EV revolution and the rise of Asia, one has to agree with the bullish thesis…for now lol….if we get a major market meltdown, or maybe “when” is better, copper will get trashed, yet it’s usefulness will not be diminished.
          One thing that makes me think of bubbles is the break with reality…so tulips, these things you can grow, eventually supply catches up. Cryptos, I read that there are 17,000 of them now, so obviously BTC is unique right? More likely it is because it was first and so has the biggest market cap so more can play with it. I am pretty sure that during the tulip mania if you tried to sell pansies or some exotic, you never would have matched the price of the viceroy.
          Ditto SPACs, what connection to reality is there?
          Bottom line, if prices make no freakin sense, start thinking bubble. In Weimar Germany stock prices went crazy, but the mark was doomed, same with Zimbabwe, so if central banks will destroy fiat currency, is the market in a bubble or not? But if I had 100 million to park somewhere, Buffett would get some, SPACs would get zero.
          NVDA has done amazingly well, but it has a good product, and who would have predicted bitcoin mining as a future demand for their product 10 years ago? This is one of those cases where if someone is in tech they can see some products with great potential.
          Another point is that if central banks want to synchro trash their fiat currencies, telling themselves that it’s all relative, if the forex pairs don’t really change it’s no big deal, do you expect them to come out and announce it?

  6. New Deal Democrat’s long leading forecast thru year end 2022: a deceleration into near recession, as of this weekend.

    So people will potentially sell into the impending rally if/when it happens.

    Of course things are fluid. It starts this week for early monthly data to shape Fed decisions. People might go crazy counting down to March Fed meeting.

  7. Adding to a few positions this morning and again breaching the 20% rule as I transition from ‘bear’ to ‘maybe the bear is behind us for now.’ Neutral for now.

    1. All remaining positions (VT/ SPT/ QQQ/ IWM) off here as it’s beginning to feel like a short squeeze.

    2. Famous last words! I was, in fact, quite bearish at the time. Now I’m looking for a ZBT. That’s how daytrading works.

    3. Feet to fire – in the absence of an upside catalyst, I think the market declines over the next 2-3 days. Negative sentiment was my sole reason for buying last week. Now that the SPX is 5-7% above the lows, I need a better reason.

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