Thoughts, Tools and Data, Trading

Market Timing Using Market Breadth Indicators

I just want to share some of the market breadth indicators that I monitor for my own trading. The links to these indicators can be found under the Market Check section of the links on the front page of my blog.

% of Stocks Above Their 50-Day Moving Average

  • I look at the corresponding ones for NASDAQ, NYSE, and S&P 500 respectively.
  • Triggers
    • They trigger negative when they cross below the 70 threshold from above.
    • They trigger positive when they cross above the 30 threshold from below.
  • Performance
    • This is one of my favorite indicators and work reliably well.
    • In the current uptrend, you find that the negative trigger happens more often than the positive trigger. So while the negative trigger gets you out of the market, most of the time you have to rely on the price action of the market averages to get you back in. The positive trigger happens only when there has been a major market correction, then the positive trigger would get you back in after the major correction.
  • Divergence
    • You can also look at divergence between these indicators and the market averages. For example, Feb to May 2013 showed divergences where the indicators were trending down while the market averages were trending up. That gives you an early warning to be very cautious and look out for a market correction.
  • Current Situation
    • The NASDAQ indicator triggered negative on May 29, 2013.
    • The NYSE indicator triggered negative on May 24, 2013.
    • The S&P indicator triggered negative on May 31, 2013.

McClellan Oscillator

  • There are two, one for NASDAQ and another for NYSE.
  • Triggers
    • They trigger negative when they cross below the zero line from above.
    • They trigger positive when they cross above the zero line from below (read below note on not doing this blindly)
  • Performance
    • Works pretty well to get you out early before the correction develops further.
    • Similar to the % of stocks above 50-day moving average indicator, it may be better to rely on the price action of the market averages to get you back in, rather than the positive trigger. This is because if you look at the charts, there can be multiple instances where the indicators pops into positive territory for a day or two before going back negative again. So you don’t want to be taking positive triggers blindly.
  • Other Uses
    • The McClellan Oscillator is also good for signaling a short-term bounce.
    • When the NASDAQ McClellan Oscillator gets below -50, or when the NYSE McClellan Oscillator gets below -80, there is a good chance of a bounce coming soon.
  • Current Situation
    • The NASDAQ indicator triggered negative on May 22, 2013.
    • The NYSE indicator triggered negative on May 22, 2013.

Cumulative (New Highs – New Lows)

  • There are no specific triggers for this indicator. What I look at is the price action of this indicator, and compare that with the price action of the market averages. It is more used to look for divergences (e.g. downtrend in the indicator, yet uptrend or flat for the market indices) to get a sense of potential change in the market.

What to Do When You Get a Market Correction Signal

  • Different people trade differently, so what I am writing here is what I would do, based on my trading personality. You may very well handle this very differently depending on your time horizon, personality, trading style, etc.
  • So for me, once the McClellan Oscillators trigger negative, sell out of long stock positions. Switch to intraday trading of the E-mini S&P 500 futures.
  • Keep focusing on the intraday trading until the S&P 500 daily trend reverts back to an uptrend based on price action, preferably with confirmation from the market breadth indicators.
  • You can see from the current situation that getting out of your longs on May 23, 2013 would have saved you a lot of heartache as the market tumbled down thereafter. The increased volatility would also make intraday trading the E-minis very profitable, especially when there should be more trend days seen.
  • IBD had a pretty good warning against buying stocks during corrections. While it is very tempting to buy into ‘good stocks’ during corrections, especially those you have been eyeing for some time or those that have not (yet) been affected by the correction, you need to resist that temptation. You never know when, or if, the correction will develop into a more sustained bear market (i.e. beyond the usual 3-6 weeks of a correction).

-END-

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