Stocktake: Traders looking for signs of capitulation

Traders often look for signs of capitulation – panic, feverish selling, awful sentiment – to determine if a market bottom is near. How does the current market look?

Selling has certainly been pretty frenzied. The Nasdaq recently fell 12 per cent in just five days; as Bespoke Investment notes, you rarely see declines of that magnitude.

Looking at the S&P 500 last week, just 15 per cent of stocks traded above their 50-day moving average. The good news is that such readings are often indicative of a near-term bottom. The bad news is things sometimes get worse – during the global financial crisis, that reading fell to zero.

The Vix, or fear index, tells a similar story. It hit 35 last week, the kind of panicked reading often seen near market bottoms. Again, however, things can get worse, with post-40 readings often registered during very panicky markets.

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As for sentiment, CNN’s Fear and Greed index, a composite tool tracking seven indicators, last week fell into the “extreme fear” zone for the first since mid-March. That marked a near-term bottom, with the S&P 500 gaining 11 per cent over the following weeks.

Of course, that ultimately turned out to be a short-lived counter-trend rally, with stocks subsequently hitting new lows. Therein lies the problem – the conditions may be in place for a decent rally, but no one knows if it will be a sustainable one.