MINDTREE  
   
THE CATS AND DOGS RATIO
Using a time honored indicator for market tops.
The familiar saying in the market is, “when cats and dogs run, its time to get out of the market”. This indicator has been put to test many times and has always managed to withstand the test of times as it is proved right every single time. So, that should make it a reliable indicator, correct? Of course! But only if we knew “when cats and dogs run”!! This is the critical part of the indicator that no one really cares to answer much. Should we do it thru observation? That is possible, but very, very dicey. For, you cannot ever tell if the market has “run” far enough.
So what we really need is a simple indicator that tells us that the cats and dogs are indeed running, how long can they run and when are they nearing some exhaustion. If only we could get one single indicator to do all those things! Then most of our problems in the market would be solved! But applying some small logic, I propose a simple solution.
Among the lot I believe Silver is the weakest as it has shown the least amount of rally and lowest momentum gains. A break below $18 would be a trigger to short this commodity. See Futures chart below. A price around $14 can be looked at across the next several weeks.
Chart shows the Ratio between the Small Cap index and the Sensex. This chart is constructed by simply dividing the value of the small cap index for the day by the sensex value of the same day. We then plot the ratio. A long enough record of this data should help us to get some more insights into the way the market mind works.
I reckoned that if the money is moving away from large caps and into the small cap, then the market is undergoing a rapid shift to confidence. Buying into small cap always occurs when there is a surfeit of good feeling. Confidence makes people take risks and in the market this is reflected as a demand for the small cap. On the other extreme, nervousness leads to abandoning of the small cap (or shunning it) and a progressive drift towards the large caps. As a result of this mind set, we should be seeing alternating sequence of mindset shifts which should become visible on the chart.
Looking at the chart, we can find some typical points. First, note that the three year history gives us a range between 0.40 at the lows to 0.80 at the highs. Since we have witnessed some very strong bullish runs as well as devilishly deep bearish drops during the 2005-2208 period, it can be expected that this range in the indicator is a reliable one and also should hold for quite a while.
Next we get two high readings- one at 0.76 and another at 0.68. At both these junctures, the market was about to form a significant top. The highs in the ratio chart were recorded a few days prior to the actual top. So, this kind of establishes a high range point (around 0.70 and higher) when the market is making a run.
Next note that the lows on this indicator hit about 0.45 and have run into this zone several times. So, it does appear that around these levels, people simply stop selling out small cap stocks as they hit deep oversold levels. These could be also the times when there is flight towards safety in the market.
We also see a good ranging action between 0.45-0.55 and looking at the index charts as well as the overall market, we found this zone to be the area between Aug0Sep 07 to Nov 07 when the large caps took over the market and ran the index up sharply. The small caps then joined the party much later and this turned into a flood, helping the indicator post a high at 0.68 by early Jan 08. The market topped out a few days later.
So what we have here is a slightly better way of estimating when cats and dogs are running. They are doing so when the Sen-Small indicator hits levels above 0.65. That is the time to become alert and start checking for market top indications. The signal can be fine tuned by looking at the indicator chart and noting where the acceleration occurs on the indicator (possibly from a basing action earlier) and if this carries the indicator towards 0.70 levels or better, then that would be the time to start booking profits or tightening the stoploss levels on holdings.
We can also estimate that when the index begins to push beneath 0.55, there is a gradual shift towards the large caps and hence readers should also do likewise. The market gets into an oversold status when the indicator hits about 0.45. Here too, one should look for the large caps to lead the market out of that trough but small caps may also bounce if it is a major low.
Current market situation shows the indicator trading around 0.49. This shows that the movement towards the large cap is still the dominant action and patronage of small cap is very restricted. Hence readers should not be turning too gung ho on the stocks from the small cap segment even if they appear cheap. There is no basing pattern yet and hence no acceleration is likely for a while.
CONTRIBUTED BY
This article is contributed by CHARTMAN.Chartman is a veteran Technical Analyst who has vast experience in capital markets. He will bring forth his experience and knowledge through interesting articles.The topics covered will range from politcal to world markets to trading psychology and other esoteric topics like derivative markets.
You can reach Chartman at mindtree@chartadvise.com
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