Let Me Save You Some Time

If you know which market indicators are valuable and which ones are bunk, you can save yourself a lot of time, effort, and money by ignoring the latter. Here are some popular indicators that might be fun to watch but that lack predictive power:

1. Hindenburg Omens: I remember the days when the mention of a single Hindenburg Omen would send people running for the sell button. Over time, it's become a standard joke that Hindenburg Omens predicted 50 out of the last 5 market selloffs (you can actually apply that joke to all of the indicators on this list). These days, would-be panic instigators are loathe to give up such a recognizable brand so easily, so the trick they use is to look for clusters of Omens. Because even if the value of a single Omen is zero, if you multiply zero five or six times, you get....oh.

2. Margin debt: The intuition behind this indicator is reasonable enough. If NYSE monthly margin debt figures climb too high, maybe it suggests that traders are over-levered, such that any routine correction will be exacerbated as traders are forced to sell to meet margin calls. You get bonus points if you mix a margin debt chart with some complaints about how quantitative easing is "forcing" people to reach for yield. However, a study by CXO Advisory found that there's very little evidence to support the view that margin debt can predict market behavior.

3. Put/call ratios: This one won't win me many friends among traders, but the evidence is pretty weak that there's any predictive value to put/call ratios. At best, they seem to be coincident indicators, measurements of where sentiment is right now rather than what's likely to happen in the future. This is true not just for equity index and equity put/call ratios, but also for CBOE Volatility Index (VIX) options. I have an article in the September 2013 issue of Active Trader with some original work on VIX options and references for the other ratios.

4. VIX "complacency": Sometimes people cite a low level of VIX as a sign that investors are too complacent about some looming risk scenario. Two quick rebuttals to this sort of thinking: first, the level of VIX is only ever meaningful in the context of current realized market volatility. A VIX of 13% is not low at all - it's high - when the actual volatility in the market over the past month has been 6%. Second, VIX uses first- and second-month options to calculate a one month estimate of implied volatility. But investors often hedge using options with much more time to expiration, and a glance at those numbers often takes the force out of a complacency claim. For example, three month VIX-style S&P 500 implied volatility closer to 15% when VIX is at 13% suggests that investors are already buying three-month SPX puts at rather high prices, in spite of recent quiet trading; that doesn't sound very complacent.

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Jared can be followed on Twitter at twitter.com/CondorOptions

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