Investors Intelligence in the stockmarket and Market Vane in the futures markets. Some advisors are veryskilled at doubletalk. The man who speaks from both sides of his mouth canlater claim that he was right regardless of the market’s direction. Editors ofInvestors Intelligence and Market Vane have plenty of experience pinningdown such lizards. As long as the same editor does the ratings, they remaininternally consistent.
Investors Intelligence
Investors Intelligence was founded by Abe Cohen in 1963. He died in 1983,and his work is being continued by Michael Burke, the new editor and pub-39. CONSENSUS INDICATORS 211
lisher. Investors Intelligence monitors about 130 stock market letters. It tabu-lates the percentage of bulls, bears, and fence-sitters among letter writers.The percentage of bears is especially important because it is emotionallyhard for stock market writers to be bearish.
When the percentage of bears among stock market letter writers risesabove 55, the market is near an important bottom. When the percentage ofbears falls below 15 and the percentage of bulls rises above 65, the stockmarket is near an important top.
Market Vane
Market Vane rates about 70 newsletters covering 32 markets. It rates eachwriter’s degree of bullishness in each market on a 9-point scale. It multipliesthese ratings by an estimated number of subscribers to each service (mostadvisors wildly inflate those numbers to appear more popular). A consensusreport on a scale from 0 (most bearish) to 100 (most bullish) is created byadding the ratings of all advisors. When bullish consensus approaches 70percent to 80 percent, it is time to look for a downside reversal, and when itnears 20 percent to 30 percent, it is time to look to buy.
The reason for trading against the extremes in consensus is rooted in thestructure of the futures markets. The number of contracts bought long andsold short is always equal. For example, if open interest in gold is 12,000contracts, then 12,000 contracts are long and 12,000 contracts are short.
While the number of long and short contracts is always equal, the numberof individuals who hold them keeps changing. If the majority is bullish, thenthe minority, those who are short, has more contracts per person than thelongs. If the majority is bearish, then the bullish minority has bigger posi-tions per person. The following example illustrates what happens when theconsensus changes among 1000 traders who hold 12,000 contracts in onemarket.
 
Open Bullish Number of Number of Contracts —_ ContractsInterest Consensus Bulls Bears per Bull per Bear12,000 50 500 500 24 2412,000 80 800 200 15 6012,000 20 200 800 60 15
 
1. If bullish consensus equals 50 percent, then 50 percent of traders arelong and 50 percent are short. An average trader who is long holds asmany contracts as an average trader who is short.212 PSYCHOLOGICAL INDICATORS
D. Mark WeeklyBullish Consensus
Figure 39-1. Bullish Consensus
The opinions of market advisors serve as a proxy for the opinions of theentire market crowd. The best time to buy is when the crowd is bearish,and the best time to go short is when the crowd is bullish. The levels ofbullishness at which to buy or sell short vary from market to market.They need to be adjusted every few months.
This weekly chart shows a bull market in the D. Mark, steadily mov-ing up between a trendline and a parallel channel line. Wheneverbullish consensus fell below 45 percent during this bull market, it gave abuy signal. The lower the bullish consensus, the more explosive the sub-sequent rally!
 
2. When bullish consensus reaches 80 percent, it shows that 80 percentof traders are long and 20 percent are short. Since the sizes of totallong and total short positions are always equal, an average bear isshort four times as many contracts as are held long by an average bull.This means that an average bear has four times more money than anaverage bull. The big money is on the short side of the market.
3. When bullish consensus falls to 20 percent, it means that 20 percent of39. CONSENSUS INDICATORS 213
traders are long and 80 percent are short. Since the numbers of longand short contracts are always equal, an average bull holds four timesmore contracts than are held by an average bear. It shows that bigmoney is on the long side of the market.
Big money did not grow big by being stupid. Big traders tend to be moreknowledgeable and successful than average — otherwise they stop being bigtraders. When big money gravitates to one side of the market, think of trad-ing in that direction.
To interpret bullish consensus in any market, obtain at least twelvemonths of historical data on consensus and note the levels at which the mar-ket has turned in the past (Figure 39-1). Update these levels once every threemonths. The next time the market consensus becomes highly bullish, lookfor an opportunity to sell short using technical indicators. When the consen-sus becomes very bearish, look for a buying opportunity.
Advisory opinion sometimes begins to change a week or two in advanceof major trend reversals. If bullish consensus ticks down from 78 to 76, or ifit rises from 25 to 27, it shows that the savviest advisors are abandoningwhat looks like a winning trend. This means that the trend is ready toreverse.
Signals from the Press
To understand any group of people, you must know what its members wantand what they fear. Financial journalists want to appear serious, intelligent,and informed; they are afraid of appearing ignorant or flaky. It is normal forfinancial journalists to straddle the fence and present several sides of everyissue. A journalist is safe as long as he writes something like “monetary pol-icy is about to push the market up, unless unforeseen factors push it down.”
Internal contradiction is the normal state of affairs in financial journalism.Many financial editors are even bigger cowards than their writers. They printcontradictory articles and call this “presenting a balanced picture.”
For example, a recent issue of Business Week had an article headlined“The Winds of Inflation Are Blowing a Little Harder” on page 19. The arti-cle stated that the end of a war was likely to push oil prices up. Another arti-cle on page 32 of the same issue was headlined “Why the Inflation Scare IsJust That.” It stated that the end of a war was going to push oil prices down.
Only a powerful and long-lasting trend can lure journalists and editors214 PSYCHOLOGICAL INDICATORS
5 ads for platinum on The WallStreet Journal futures page
| | ‘i
Platinum
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ytTIn
No ads for platinum on The WailStreet Journal futures page
Figure 39-2. Advertising as a Contrary Indicator
By the time several firms prepare ads for the same product and placethem in the same newspaper, the trend is ready to reverse. More thanthree ads for the same market on the same page is a bearish warning.
 
down from their fences. This happens when a wave of optimism or pes-simism sweeps the market at the end of a major trend. When journalistsclimb down from the fence and express strongly bullish or bearish views, thetrend is ripe for a reversal.
This is also the reason why the front covers of major business magazinesare good contrarian indicators. When Business Week puts a bull on its cover,it is usually a good time to take profits on long positions in stocks, and whena bear graces the front cover, a bottom cannot be too far away.
Signals from the Advertisers
A group of three or more ads touting the same “opportunity” on the samepage of a major newspaper often warns of a top (Figure 39-2). Only a well-40. COMMITMENT INDICATORS 215
established uptrend can break through the inertia of several brokeragefirms. By the time all of them recognize a trend, come up with trading rec-ommendations, produce ads, and place them in a newspaper, that trend isvery old.
The ads on the commodities page of the Wall Street Journal appeal to thebullish appetites of the least-informed traders. Those ads almost never rec-ommend selling; it is hard to get amateurs excited about going short. Whenthree or more ads on the same day day tout opportunities in the same market,it is time to look at technical indicators for shorting signals.
40. COMMITMENT INDICATORS
Several government agencies and exchanges collect data on buying and sell-ing by several groups of investors and traders. They publish summaryreports of actual trades—commitments of money as well as ego. It pays totrade with those groups that have a track record of success and bet againstthose with poor track records.
For example, the Commodity Futures Trading Commission (CFTC)reports long and short positions of hedgers and big speculators. Hedgers—the commercial producers and consumers of commodities—are the mostsuccessful participants in the futures markets. The Securities and ExchangeCommission (SEC) reports purchases and sales by corporate insiders.Officers of publicly traded companies know when to buy or sell their com-pany shares. The New York Stock Exchange reports the number of sharesbought, sold, and shorted by its members and by odd-lot traders. Membersare more successful than small-time speculators.
Commitments of Traders
Traders must report their positions to the CFTC after they reach certain lev-els, called reporting levels. At the time of this writing, if you are long orshort 100 contracts of corn or 300 contracts of the S&P 500 futures, theCFTC classifies you as a big speculator. Brokers send reports on positionsthat reach reporting levels to the CFTC. It compiles them and releases sum-maries once every two weeks.
The CFTC also sets up the maximum number of contracts, called position216 PSYCHOLOGICAL INDICATORS
limits, that a speculator is allowed to hold in any given market. At this time,a speculator may not be net long or short more than 2400 contracts of corn or500 contracts of the S&P 500 futures. These limits are set to prevent verylarge speculators from accumulating positions that are big enough to bullythe markets.
The CFTC divides all market participants into three groups: commercials,small speculators, and large speculators. Commercials, also known ashedgers, are firms or individuals who deal in actual commodities in the nor-mal course of business. In theory, they trade futures to hedge business risks.For example, a bank trades interest rate futures to hedge its loan portfolio, ora food processing company trades wheat futures to offset the risks of buyinggrain. Hedgers post smaller margins and are exempt from speculative posi-tion limits.
Large speculators are those traders whose positions reach reporting lev-els. The CFTC reports buying and selling by commercials and large specula-tors. To find the positions of small traders, you need to subtract the hold-ings of the first two groups from the open interest.
The divisions between hedgers, big speculators, and small speculators aresomewhat artificial. Smart small traders grow into big traders, dumb bigtraders become small traders, and many hedgers speculate. Some market par-ticipants play games that distort the CFTC reports. For example, an acquain-tance who owns a brokerage firm sometimes registers his wealthy speculatorclients as hedgers, claiming they trade stock index and bond futures to hedgetheir stock and bond positions.
The commercials can legally speculate in the futures markets using insideinformation. Some of them are big enough to play futures markets againstcash markets. For example, an oil firm may buy crude oil futures, divert sev-eral tankers, and hold them offshore in order to tighten supplies and pushfutures prices up. They can take profits on long positions, go short, anddeliver several tankers at once to refiners in order to push crude futuresdown and cover shorts. This manipulation is illegal, and most firms hotlydeny that it takes place.
AS a group, the commercials have the best track record in the futures mar-kets. They have inside information and are well-capitalized. It pays to followthem because they are successful in the long run. The few exceptions, suchas orange juice hedgers, only confirm this rule.
Big speculators used to be highly successful as a group until a decade orso ago. They used to be wealthy individuals who took careful risks with theirown money. Today’s big traders are commodity funds. These trend-follow-40. COMMITMENT INDICATORS 217
ing behemoths do poorly as a group. The masses of small traders are theproverbial “wrong-way Corrigans” of the markets.
It is not enough to know whether a certain group is short or long.Commercials are often short futures because many of them own physicalcommodities. Small traders are usually long, reflecting their perennial opti-mism. To draw valid conclusions from the CFTC reports, you need to com-pare current positions to their historical norms.
The moder approach to analyzing commitments of traders has been devel-oped by Curtis Arnold and popularized by Stephen Briese, publisher of theBullish Review newsletter. These analysts measure deviations of current commit-ments from their historical norms. Bullish Review uses the following formula:
Current Net - Minimum Net
COT Index = ————___________Maximum Net — Minimum Netwhere COTIndex = commitments of Traders Index.Current Net = the difference between commercial and
speculative net positions.
Minimum Net = the smallest difference between commer-cial and speculative net positions.
Maximum Net= the largest difference between commercialand speculative net positions.
Net Position = long contracts minus short contracts of anygiven group.
When the COT Index rises above 90 percent, it shows that commercialsare uncommonly bullish and gives a buy signal. When the COT Index fallsbelow 10 percent, it shows that commercials are uncommonly bearish andgives a sell signal.
Insider Trading
Officers and investors who hold more than 5 percent of the shares in publiclytraded companies must report their buying and selling to the Securities andExchange Commission. The SEC tabulates insider buying and selling andreleases this data to the public once a month.
Corporate insiders have a record of buying stocks cheap and selling dear.Insider buying emerges after severe market drops, and insider selling accel-erates when the market rallies and becomes overpriced.218 PSYCHOLOGICAL INDICATORS
Buying or selling by a single insider matters little. For example, an execu-tive may sell shares in his firm to meet major personal expenses or may buyshares to exercise stock options. Analysts who researched legal insider trad-ing found that insider buying or selling was meaningful only if more thanthree executives or large stockholders bought or sold within a month. Theseactions reveal that something very positive or negative is about to happen tothe firm. A stock is likely to rise if three insiders buy in one month and tofall if three insiders sell within a month.
Stock Exchange Members
Membership in a stock exchange — particularly as a specialist—is a licenseto mint money. An element of risk does not deter generations of traders frompaying hundreds of thousands of dollars for the privilege of planting theirfeet on a few square inches of a crowded floor.
The Member Short Sale Ratio (MSSR) is the ratio of shorting by mem-bers to total shorting. The Specialist Short Sale Ratio (SSSR) is the ratio ofshorting by specialists to shorting by members. These indicators used toserve as the best tools of stock market technicians. High readings of MSSR(over 85 percent) and SSSR (over 60 percent) showed that savvy traderswere selling short to the public and identified stock market tops. Low read-ings of MSSR (below 75 percent) and SSSR (below 40 percent) showed thatmembers were buying from the bearish public and identified stock marketbottoms. These indicators became erratic in the 1980s. They were done in bythe options markets, which gave exchange members more opportunities for’arbitrage. Now it is impossible to tell when their shorting is due to bearish-ness or to arbitrage plays.
Odd-Lot Activity
Odd-lotters are people who trade less than 100 shares of stock at a time — thesmall fry of the stock exchange. They remind us of a more bucolic time onWall Street. Odd-lotters transacted one quarter of the exchange volume acentury ago, and 1 percent as recently as two decades ago. Odd-lotters as agroup are value investors. They buy when stocks are cheap and sell whenprices rise.
The indicators for tracking the behavior of odd-lotters were developed in40. COMMITMENT INDICATORS 219
the 1930s. The Odd-Lot Sales Ratio measured the ratio of odd-lot sales topurchases. When it fell, it showed that odd-lotters were buying and the stockmarket was near the bottom. When it rose, it indicated that odd-lotters wereselling and the stock market was near the top.
The Odd-Lot Short Sale Ratio was a very different indicator. It trackedthe behavior of short-sellers among odd-lotters, many of whom were gam-. blers. Very low levels of odd-lot short sales indicated that the market wasnear the top, and high levels of odd-lot short sales showed that the stockmarket was at a bottom.
These indicators lost value as the financial scene changed in the 1970sand 1980s. The intelligent small investors moved their money into well-runmutual funds, and gamblers discovered that they could get more bang fortheir money in options. Now the New York Stock Exchange has a preferen-tial mechanism for filling odd-lot orders, and many professionals trade in 99-share lots.VillNew Indicators
 
41. ELDER-RAY
Elder-ray is a new technical indicator. It was developed in 1989 by thisauthor and named for its similarity to X-rays. Doctors use X-rays to see bonestructure below the surface of the skin. Traders can use Elder-ray to see thepower of bulls and bears below the surface of the markets.
To be a successful trader, you do not have to forecast the future. You needto find when bulls or bears are in control and trade with the dominant group.Elder-ray helps you see when bulls and bears become stronger or weaker.
How to Construct Elder-ray
Elder-ray combines the best features of trend-following indicators and oscil-lators (see Section 24). It includes an exponential moving average, which isa trend-following indicator. Its Bull Power and Bear Power components areoscillators.
To create Elder-ray, divide your computer screen or chart paper into threehorizontal windows. Plot a bar chart and an exponential moving average(EMA) in the upper window. Plot Bull Power in the middle window andBear Power in the bottom window.
It takes four steps to construct Elder-ray (see worksheet, Figure 41-1).
22041, ELDER-RAY 221
13-EMA | Bull Power ; Bear Power
10/02 {| 360.8 |Figure 41-1. Elder-ray Worksheet
Bull Power = High of the bar - 13-day EMA.Bear Power = Low of the bar - 13-day EMA
It is normal for Bull Power to be positive and for Bear Power to benegative. The higher the Bull Power, the stronger the bulls, and thedeeper the Bear Power, the stronger the bears. When Bull Power turnsnegative, it shows that the bears are so strong they completely over-power the bulls. If Bear Power turns positive, it shows that bulls areuncommonly strong, completely overpowering the bears.
 
1. Draw a bar chart of any trading vehicle in the top window of yourscreen.
2. Plot an EMA of closing prices in the same window. A 13-day EMA isa good choice.Bull Power = High- EMABear Power = Low - EMA
3. Calculate Bull Power according to the above formula. Plot it as a his-togram in the middle window. Bull Power of any day equals the highof that day minus the EMA of that day. Normally, the high of a bar isabove the EMA, Bull Power is positive, and the histogram is above222 NEW INDICATORS
the centerline. The entire bar may sink below the EMA during a sharpbreak. When the high is below the EMA, Bull Power turns negativeand its histogram falls below the centerline.
4. Calculate Bear Power and plot it as a histogram in the bottom window.Bear Power of any bar equals the low of that bar minus the EMA.Normally, the low of a bar is below the EMA, Bear Power is negative,and the histogram is below the centerline. If the entire bar rises abovethe EMA during a sharp rally, then Bear Power turns positive and itshistogram rises above the centerline (Figure 41-2).
Trading Psychology
Elder-ray combines several pieces of information: price, a moving average,the high of each bar, and the low of each bar. We need to understand theirmeaning in order to understand Elder-ray.
Each price is a momentary consensus of value (see Section 12). Buyersare buying because they expect prices to rise. Sellers are selling becausethey expect them to fall. The undecided traders are standing aside, but theirpresence puts pressure on bulls and bears. A trade takes place when abuyer is willing to buy and a seller is willing to sell, both prompted by fearthat an undecided trader may step in and snap away an opportunity. Theprice of every trade reflects the latest consensus of value of any tradingvehicle.
A moving average shows the average consensus of value during its timewindow. A 10-day MA represents the average consensus of value for thepast 10 days, a 20-day MA for the past 20 days, and so on. An exponentialmoving average is more reliable than a simple MA (see Section 25). Themost important message of a moving average is its slope. When it rises, itshows that the crowd is becoming more bullish. When it declines, it showsthat the crowd is becoming more bearish. Trade in the direction of the slopeof a moving average.
The high of any bar reflects the maximum power of bulls during that bar.Bulls make money when prices rise. They keep buying until they cannot liftprices any higher. Bulls would love to raise prices one more tick — but theyare out of breath. The high point of a daily bar represents the maximumpower of bulls during the day, the high point of a weekly bar represents themaximum power of bulls during the week, and so on.
The low of any bar represents the maximum power of bears during that    
    
 
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The 13-day EMA reflects the average consensus of value; its slope identi-fies the market trend. Bull Power reflects the ability of bulls to lift pricesabove the average consensus of value. Bear Power reflects the ability ofbears to push prices below the average consensus of value.
The best buy signals are given by bullish divergences—when prices fallto a new low, but Bear Power stops at a more shallow bottom. The bestshorting signals are given by bearish divergences-when prices rise to orabove the previous high, but Bull Power reaches a lower peak.
A bearish divergence in June and July gave a sell signal-a double topin price, accompanied by a lower peak in Bull Power. The sell signalwas confirmed when the 13-day EMA turned down. Bull Power becamepositive several times during the downtrend, showing where to add toshort positions. When Bull Power turns positive during a downtrend andthen ticks down, place an order to sell short below the last day's low.
A bullish divergence developed in September when gold fell to a newlow, but Bear Power made a more shallow low. The buy signal was con-firmed when the 13-day EMA of gold turned up. At the right edge of thechart, the new peak in Bull Power confirms that the rally is strong andlikely to continue.224 NEW INDICATORS
bar. Bears make money when prices fall. They keep selling and shortinguntil they cannot push prices down another tick. The lowest point of a dailybar reflects the maximum power of bears during the day, the low of a weeklybar shows the maximum power of bears during the week, and so on.
Elder-ray compares the maximum power of bulls and bears to the averageconsensus of value. It does this by measuring the spread between the highand the low of every bar and an exponential moving average.
Bull Power reflects the bulls’ ability to push prices above the averageconsensus of value. It measures the distance from the bar’s high to the EMA.Bull Power is normally positive. It rises when bulls become stronger andfalls when they stumble. Bear Power tums negative when bulls’ heads areunder water.
Bear Power reflects the bears’ ability to push prices below the averageconsensus of value. It measures the distance from the bar’s low to the EMA.Bear Power is normally negative. It deepens when bears grow stronger andrises when they become weaker. If Bear Power turns positive, it shows thatvery strong bulls are holding bears up in the air by the scruff of their necks.
To summarize the key points of Elder-ray:
1. Price is a consensus of value, expressed in action.2. A moving average is an average consensus of value.
3. The highest point of each bar represents the maximum power of bullsduring that bar.
4. The lowest point of each bar represents the maximum power of bearsduring that bar.
5. Bull Power is the difference between the raw power of bulls and theaverage consensus of value.
6. Bear Power is the difference between the raw power of bears and theaverage consensus of value.
Trading Rules
Elder-ray can work as a stand-alone trading method, but it pays to combine itwith another method, such as the Triple Screen trading system (see Section43). If you use Elder-ray alone, remember that the slope of its EMA identifies41. ELDER-RAY 225
the trend, and trade only in that direction. Use Bull Power and Bear Power tofind entry and exit points for your trades in the direction of that trend.
Triple Screen, on the other hand, identifies the trend using weekly charts.It then uses Bull Power and Bear Power on the daily charts to find trades inthe direction of the weekly trend. If the weekly trend is up, Triple Screentakes only buy signals from daily Elder-ray. If the weekly trend is down, ittakes only shorting signals from daily Elder-ray.
Buying and SellingThere are two essential conditions for buying:
1. The trend is up (identified by EMA or a weekly trend-following indi-cator).
2. Bear Power is negative but rising.The third and fourth conditions are desirable but not essential:3. The latest peak in Bull Power is higher than the previous peak.
4. Bear Power is rising from a bullish divergence.
Do not buy when Bear Power is positive. This occurs in runawayuptrends, when the entire bar rises above the EMA. If you buy when bearsare being held up in the air, you are betting on the greater fool theory — pay-ing a high price and hoping to meet a greater fool down the road willing tobuy from you at an even higher price.
The best time to buy is when Bear Power is negative but rising — whenbears regain their footing but are starting to slip again. When Bear Powerticks up, place a buy order above the high of the last two days. If the tallycontinues, your stop will be touched and you will go long. Once long, placea protective stop below the latest minor low.
The strongest buy signals are given by bullish divergences between BearPower and price. If prices fall to a new low but Bear Power traces a higherbottom, it shows that prices are falling out of inertia and bears are becomingweaker. When Bear Power ticks up from the second bottom, buy a largerthan usual position.
Bear Power is useful for deciding when to pyramid. As the uptrend con-tinues, you can add to your long position whenever Bear Power dips belowits centerline and then ticks up again.226 NEW INDICATORS
If you buy using indicators, use them to decide when to sell. Do not bedistracted by every uptick and downtick of Bull Power—its normal breath-ing process. You can monitor the power of bulls by tracking the pattern ofpeaks and valleys in Bull Power. As long as every new peak in price isaccompanied by a new peak in Bull Power, the uptrend is safe. Sell whenbulls start losing power. A sell signal is given when prices reach a new highbut Bull Power reaches a lower peak than it reached during its previous rally.
Shorting and CoveringThere are two essential conditions for shorting:
1. The trend is down (identified by EMA or weekly trend-following indi-cator).
2. Bull Power is positive but falling.
The third and fourth conditions are desirable but not essential:3. The latest bottom in Bear Power is deeper than its previous bottom.
4. Bull Power is falling from a bearish divergence.
Do not sell short if Bull Power is already negative. This happens when thewhole price bar is below the EMA —during a waterfall decline. If you sellshort when bears already have bulls’ heads under water, you are betting thatbears can push bulls’ heads even deeper. This is another version of thegreater fool theory.
The best time to sell short is when Bull Power is positive but falling. Itshows that bulls have come up for air but are starting to sink again. Place anorder to sell short below the low of the last two days. If the decline contin-ues, you will be stopped in automatically. Once short, place a protective stopabove the latest minor high.
The strongest shorting signals are given by bearish divergences betweenBull Power and prices. If prices rally to a new high but Bull Power reaches alower top, it shows that bulls are weaker than before and prices are rising outof inertia. When Bull Power ticks down from a lower top, sell short a biggerposition.
Bull Power shows when to pyramid short positions. As a downtrend con-tinues, you can add to your shorts whenever Bull Power rallies above its cen-terline and then ticks down again.
If you sell short using indicators, use them also for deciding when to42. FORCE INDEX 227
cover. When the trend is down, monitor Bear Power to see whether bears arebecoming stronger or weaker. The pattern of peaks and valleys in BearPower is much more important than its single upticks and downticks. If anew low in price is accompanied by a new low in Bear Power, the down-trend is safe.
A bullish divergence occurs when prices fall to a new low but Bear Powertraces a more shallow bottom. It shows that bears are running out of steamand prices are falling out of in