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Complacency Is Making the Contrarians Nervous

According to the AAII survey, 65.5% of individual investors were bullish, 17.2% were neutral and 17.2% were bearish in the week ending Dec. 24. The bull number was up and the bear number down slightly from the week prior, another worrisome sign for a contrarian.

When the U.S. stock market was about to ignite in early March, the readings stood at 33.3% bullish, 39.4% bearish and 27.3% neutral.

CBOE Volatility Index

For contrarian and lay-trader purposes, the Chicago Board of Exchange Volatility Index, or VIX, is most usefully referred to as the market's "fear gauge."

Technically speaking, however, the VIX is a measure of the level of implied price volatility of the S&P 100.

RealMoney options guru Steve Smith explains the predictive nature of the VIX: "The underlying theory is that at any given moment in time, the majority opinion is wrong. A rising stock market is viewed as less risky than a declining stock market. The higher the perceived risk is in stocks, the greater the demand for protective options, driving up prices and sending implied volatility higher. Hence, if everyone is in a panic, selling stocks and buying puts, the bottom might be at hand."

Smith notes that as a contrary indicator, the VIX is more reliable for defining market bottoms, expressed in extreme "fear," or high volatility, than for flagging tops based on "complacency," or low volatility.

The VIX currently stands at an exceedingly complacent 17.41. Back in early March the VIX stood above 30 before spending the remainder of the year in free fall.

VIX readings above 45 have marked major market bottoms and ensuing rallies in the past.

CBOE Put-to-Call Ratio

The name of this indicator refers to the two main options classes, those that become valuable when the underlying stocks fall (puts) and rise (calls). The put-to-call ratio is simply the volume of all puts divided by the volume of all calls that trade on a particular day. Like the VIX, the put-to-call ratio runs in direct proportion to investors' nerves: The higher the number, the shakier their knees.

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