The important thing to keep in mind about the BoP is that it’s a visual representation of herding in the financial markets and when a new rally or decline is starting it always starts from the very first column on the left because it’s the most recent representation of herding activity and as more and more of the herd join in the move it fills out to the right of the BoP section.
You don’t need to wait until the first three columns are filled to take a position, in fact you shouldn’t especially when MTSD and MTVol are indicating a move is imminent, but the BoP will confirm the move and, depending on how ‘well formed’ it is, the potential for the size of the move.
The image below shows a transition from bearish herding to bullish herding in the BoP.
This example is about as good and as near ‘perfect’ of herding as you’ll see in any time period so study them closely.
Both of the moves were substantial.
The bearish trade started on 9/19/14 when MTVol rose above 100% and we got a “selling on the advance’ signal for the day. We also started to see the 1st column of the BoP bearish section start to ‘fill’.
• TIP: The 1st column on either the bullish or bearish side is the most important column in the BoP because it’s the most recent herding impulse. NO significant rally or decline has ever started without that 1st column filling out first.
From 9/19 to 10/16 the bearish herding as well formed and only a few gaps were noticed in the cells on the bearish side.
There were also a few ‘bullish’ herding attempts but as you can see they were single herding formations that never gathered any momentum (followers) and simply died out.
A clue that the selling was just about exhausted happened on 10/15: The DOW declined 173 points but MTSD was only -1. In addition, there was no bearish herding in the 1st column that day. For a move that size, with no bearish herding in the 1st column is a signal that the bearish herd was starting to scatter and no longer had the strength to continue.
The very next day on the 16th we got a small decline but with a +10 on the MTSD Index! That’s ‘buying on the decline’ – we also got the 1st column of the BoP bullish side filling out.
A single 1st column on the bullish side is not enough on its own to generate an ‘UP’ signal for our model but that along with the ‘buying on the decline’ and the previous days readings indicate the market is about to go into rally mode.
Once we see the BoP starting to fill out from left (1st column) to right we get a sense that the move could be large:
• TIP: If you follow the 1st column down during the decline and then the rally you’ll see that many of them were filled out. Filling out those 1st columns as the swing move develops gives you some confidence that the move will not only be potentially large but that it could last for quite a while.
There’s one other thing we look at for potential direction of the market – the number of 1st columns filled because the 1st column is the most important due to recency.
In the following example we had 2 days in the 1st column on the bearish side of the BoP and 1 day in the 1st column on the bullish side. So we saw more net days bearish than bullish this week by that measure as illustrated below:
Using this example, we could argue then that overall bearish herding increased this week based on recency of the 1st column BoP despite the fact there were more BoP cells filled on the bullish side rather than the bearish side.
Example above: The ‘bear orphan’ indicates that the bears could not form a herd large enough to push the market significantly lower.
An orphan is an attempt by the bulls or bears to push the market in one direction but failed to convince others to join in which leaves a single cell filled in but alone in the BoP.
The 1st column being the most recent attempt at herding is considered to be the most important for initial formation of the herd.
The herding seen in columns furthest to the right from the 1st column are distant attempts at herding and generally do not affect the market the farther they are from the 1st column.
They are important however in our analysis especially when they form ‘bear traps’ and ‘bull traps’ and our longer-term views of the market.