What is a Squeezeometer ?
A core function of our research centers on the concept of advance phases and decline phases. Whether we're in a bull or bear market, there is a constant swing from excesses of bullish sentiment to excesses of bearish sentiment. The market seems to wait for an excess to appear before shifting direction. Hence, each "phase" is a squeeze play. Someone (either bull or bear) is being squeezed out of the market – we want to be on the side of the “squeezer”, not the “squeezee.” Erlanger Chart Room is designed to give the user the necessary information to do just that.
We have observed that these “squeeze play” phases occur on an intermediate-term, long-term and mega-term basis. We judge each term by looking at daily, weekly and monthly data, respectively.
Our "Squeezeometer" table is designed to indicate which phase (advance or decline) is underway for each of the four terms. Moreover, each phase has two sections to indicate contra-trend turns in the direction of the phase. Since there are two sections to each of two phases, there are four rows in our Squeezeometer table:
Note that only one "cell" in each column is active. An active cell is identified by colors and numbers. “Rally in a downtrend” and “Uptrend” designations are always colored as green, because buy/speculative buy tactics are usually appropriate at such times. Other cells are colored red when appropriate.
The numbers you see in some cells (the active ones) represent our buy or sell confidence index (see explanation below). We actually have three sets of "Buy" and "Sell" indices -- a set for each of mega, long and intermediate terms.
As our various indicators highlight the market's price action, the various cells become active, indicating the posture of the market. The confidence index numbers indicate the squeeze potential during each of the four stages. In the "advance" and “rally in a downtrend” phase stages, the confidence numbers are derived from the "buy confidence index" for that column's periodicity (monthly, weekly, daily or hourly). In the "decline" and “pullback in an uptrend” phase stages, the confidence numbers are derived from the "sell confidence index". As a phase begins, the typical behavior is for confidence to be high (up to a maximum of 100). As the phase progresses, it is reasonable to expect the confidence index (a measure of sentiment) to decrease.
In the table above, the LT column is active (filled by the color red) on the cell marked "downtrend". The number "82" tells us that the Sell Confidence Index based on weekly data is on the high side. This number can actually get to zero if the VIX rises enough (see Confidence Index section, below.) Remember, the more optimistic the sentiment, the more confidence we have in being bearish ourselves. In such situations, the bulls are the majority and most at risk of being squeezed.
It's often easy to get caught up in short-term moves. The Squeezeometer is designed to track the hourly shifts in the market, but it is also designed to force us to remain aware of the bigger picture represented by the daily and weekly statistics. In our experience, the bigger picture is of greater value than the shorter-term fluctuations.
The first 2 rows of the Squeezeometer are advance phase measures. If a cell is activated (activation is manifested by a number and a color inside a cell) in the first row, this means the price action is in an uptrend. If a cell is activated in the second row, this means the price action is moving somewhat contrary to the advance phase -- a correction or pullback. While the second row is activated, price action could be either sideways or in a mild decline. Speculators can sell these in anticipation of downside momentum gaining power, so that a full blown decline phase ensues. If, however, there is a protracted period of sideways price action while the second row is activated, the advance is considered to have only paused for a breather, and a move back to an uptrend is expected. The third row depicts a clear downtrend direction in price action. The fourth row is the reverse of row 2 (corrective action for a decline phase would be sideways to slightly advancing price action – a rally!) Hence, rows 1 and 3 are clear depictions of trend direction. Rows 2 and 4 are depictions of contra-trend action. Therefore, the cells of the Squeezeometer become active based on the Erlanger Trend Direction indicator (which can be used in Erlanger Chart Room on any stock of index.
Indicator Focus: Buy/Sell Confidence Index
Options trading and short selling are great measures of sentiment. One indicator we have used is the CBOE Volatility Index (VIX). The VIX measures the willingness of traders to overpay for OEX put options relative to call options. Therefore, the higher the VIX, the more bearish the prevailing sentiment is.
Adding to our arsenal, we have crafted a tool called the Buy/Sell Confidence Index, which is an important part of our "Squeezeometer". When the Buy Confidence Index is high, sentiment as expressed by the VIX is excessively bearish. When the Sell Confidence Index is high, sentiment as expressed by the VIX is excessively bullish. The Buy/Sell Confidence Index can be calculated on an daily, weekly or monthly basis. In order to see how this indicator may be used as a decision making tool, we will examine the daily Buy/Sell Confidence Index.
In the example chart above, the daily Buy Confidence Index is down to 17%, a reflection of a recent rally that occurred. The “sell” confidence index rises as fear subsides. Generally, we are more confident about selling when the majority is bullish. The active cell in the daily column of the NASDAQ Squeezeometer above is row four – “rally in a downtrend.” Therefore, the number in the cell is 17 (the daily buy confidence you see in the above chart.) Because this is a low number, we would have less confidence in the buy nature of the active cell than otherwise.
In the Squeezeometer, the intermediate-term and long-term confidence indices are a reflection of the action of the VIX. The mega-term (monthly) confidence indices reflect the short selling of the underlying index component issues.