Stock Market Caution Flags: Put/Call Ratio And Price Divergences
The steady stream of higher price highs in well-loved favorites like Microsoft, Apple, Amazon, Google and Tesla is good news for shareholders. There’s nothing better in the investment world than holding something that’s becoming more valuable week after week, month after month.
This is true except for the emergence of certain stock market caution flags that bear your attention. The extreme reading of the put/call ratio may be the most obvious but the divergences between index price and key momentum indicators also deserves your notice.
Here’s the CBOE total put/call ratio:
Very few puts are being bought these days in comparison to heavy buying of calls. Speculators buy calls when they believe prices will continue to rise. They buy puts when the think prices may fall. That this ratio is nearing the lower Bollinger Band (a standard deviation measure) suggests that perhaps bullish sentiment has become extreme.
Here are the price divergences on the Standard & Poor’s 500 daily price chart:
The moving average convergence/divergence indicator is diverging negatively from the price movement. You can see that the index itself has moved higher in February than its January high price — but the MACD indicator is not keeping up. That’s a negative divergence confirmed by the price momentum oscillator also shown.
Here’s the NASDAQ Composite daily price chart:
This chart is a little different than the S&P 500 chart but the upshot is the same. The NASDAQ has moved much higher in February than its January peak. The moving average convergence/divergence indicator is not keeping up — it’s moved only sideways. It’s the same thing with the price momentum oscillator. These indicators are failing to confirm the blast upward in price.
And one more, just for the record. Here’s the daily price chart of the small cap Russell 2000 index:
You can see that the small cap index has not been keeping up with the other widely followed, major stock market indices. The February advance has not made it higher than the January high and not much higher than the peak that came late last year. Both the MACD and the PMO indicators are failing to improve.
None of this means that stocks can’t continue to advance. They sometimes have a way of continuing higher despite indicators suggesting a tiring of underlying strength. That small cap decline coming at a time when Microsoft, Apple and Google continue upward shows how investors are piling into big names at the expense of the less known.
I do not hold positions in these investments. No recommendations are made one way or the other. If you’re an investor, you’d want to look much deeper into each of these situations. You can lose money trading or investing in stocks and other instruments. Always do your own independent research, due diligence and seek professional advice from a licensed investment advisor.