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Market Breadth

Stocks Up or Down 25% in a Quarter

There is a breadth measure that I’ve been keeping an eye on. It is simply a count of the number of stocks that are up and down 25% or more in a quarter. Here is a good primer on this breadth measure: How to Use Market Breadth to Avoid Market Crashes.

Let’s take a long-term look at how this particular breadth measure has performed (click to enlarge):

Up or Down 25 pct in a quarter

The red is the number of stocks down 25% or more in a quarter (65 days) and the green is the number of stocks up 25% or more in a quarter. What is obvious is that every crash or bear market was preceded by the red measure growing and the green measure shrinking.

I like this indicator, and I think it will work, but I’m not quite sure how to use it, yet. I need to do some backtesting and figure out what it looks like to be in cash when there are fewer stocks up 25% or more in a quarter then the number of stocks down 25% or more in a quarter. Also, most times that the red is higher than the green, nothing major happens, and the market resumes the uptrend. Does this indicator give any clues that something more than a normal correction is ahead? I don’t know, but I’m going to poke at it a little bit and see what happens.

The good news is that the current reading shows that there are 596 stocks up 25% or more and only 439 stocks down 25% or more. This lends weight to my current stance that we are just experiencing a normal market correction.

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Looks Like a Tradeable Bounce Ahead

Keeping with my recent theme of using two indicators to gauge market swings, the bloodbath of the last two days has again aligned these indicators so that they are suggesting a tradeable, 3 – 5 day bounce is ahead. Let’s take a look…


6_20 Breadth

The green Decline Line Indicator is maxed out at 100.

The red Number of Stocks Trading Above Their 5 Day Moving Averages Indicator is reading 316, which is well below the preferred threshold of 650.

As shown in the chart, when these indicators align, a tradeable bounce tends to occur. I set the arrows up to reflect a 3 day hold time after the signal.

The wildcard is of course that we are in a downtrend, which changes things. You’ll note that most of the bounces on the chart above have come during pullbacks in an uptrend. Because of the strength of this sell-off, I’m looking for a bounce that will rise only to the 50 day average. From there, I’m expecting we’ll see the old Bears at the Honey Hole routine.

How $SPY behaves on this bounce (if it does bounce) will help me decide what to do with my long-term $SPY long position.

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Falling Under the 50 Day Average on Thursday?

Exactly one week ago I wrote the following:

My best guess is that we see some stabilization around the 50 day average. I would not be surprised by another quick and small bounce. But ultimately I am expecting $SPY to trade beneath the 50 day average, within a week.

That prognostication came at the end of a series of posts where I explained how I used a couple of breadth indicators to predict and gauge the strength of bounces.

I was wrong about the $SPY trading beneath the 50 day average within a week, and the bounce was stronger than I expected. However, it appears as if the correction will continue, and $SPY looks as if it may close beneath the 50 day as early as tomorrow (Thursday). So maybe I was off by a day. The most important point is that these breadth indicators do a nice job of calling short-term market swings.

The indicators by themselves help a lot, but they should be combined with experience for the best results. Since I believe that we are in a corrective phase, my experience tells me that we will see less trending and more mean reversion until the correction is over. This means that up and down swings are to be expected, which is why I figured the market would be headed back down, within a week.

Another way of looking at this is to consider that today’s move was less about Bernanke and more about the market being in a corrective phase. Trending markets don’t move up and down + or -1% several times a week. Markets in a corrective phase do experience the large swings.

All that being said, what are the breadth indicators indicating?

6_19 Breadth

The very short term Decline Line Indicator (green line) is reading 99.6, which means that stabilization, or a bounce, is imminent.

The short-term Number of Stocks Beneath Their 5 Day Moving Average Indicator (red line) is at 1142. This indicator needs to be beneath 650 in order for me to expect a tradeable bounce.

I’m still expecting a close beneath the 50 day average, but the extreme Decline Line Indicator reading means we may see a pause tomorrow, with the correction resuming shortly thereafter.


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Another Tradeable Bounce, or Lower Lows?

In several recent posts I discussed how I use a couple of breadth indicators. The last post, Now I’m Looking for a Tradeable Bounce, was spot on:

The good news is that both indicators are now aligned which means I feel comfortable looking for a tradeable bounce. This means I expect a bounce that will last 3 to 5 days.

So the bounce lasted 3 days and we have fallen for 2 days. The indicators are again pointing to a tradeable bounce. But will we get the bounce again?

The short, honest answer is I don’t know.

There are examples of the indicators working over and over again in rapid succession. See September and October of 2012 in the chart below. However, when the market is correcting, eventually a lower low will occur. I believe the market is in a corrective phase, so it makes sense to me to expect lower lows. Will they come after another tradeable bounce?

A couple of factors worth considering: The 50 day average will act as an area of support, and the expectation is NOT for the economy (or the market) to completely fall apart. Those of you who remember well what it was like to trade from 2007 – 2009 should note that we are not staring down an Armageddon. Instead, the odds are that we are simply having to shrug off a garden-variety market correction. If you didn’t trade during the Great Recession, then you should be accepting that market corrections are just part of the game.

Breadth 6_13

We are focused on the green “decline line” indicator and the red “number of stocks above their 5 day moving average” indicator. Both are aligned at levels that typically indicate an imminent bounce that may last 3 – 5 days.

My best guess is that we see some stabilization around the 50 day average. I would not be surprised by another quick and small bounce. But ultimately I am expecting $SPY to trade beneath the 50 day average, within a week.

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Now I am Looking for a Tradeable Bounce

In two recent posts, Short Term Breadth Pointing to a Bounce, and So We Got the Bounce. Now What, I discussed how to interpret two of the indicators I use and walked the reader through my thinking when interpreting them. You’ll see that the indicators were accurate in predicting the first three days of this week.

The good news is that both indicators are now aligned which means I feel comfortable looking for a tradeable bounce. This means I expect a bounce that will last 3 to 5 days.

Let’s have a look…Click on the chart to enlarge it.

Breadth 6_5

Note that the very short term decline line indicator (green line) is above 99, which means a bounce (or stabilization) is imminent.

The short term “number of stocks above their 5 day moving average” indicator (red line) is also beneath the trigger area of 650 with a reading of 449. This is the lowest reading for this indicator in 2013. The last time we had a reading lower than this was November 14th, 2012, at 388. This date was two days before the absolute low of the Fall 2012 correction.

These indicators do not guarantee a tradeable bounce, but the odds are on our side. Couple the odds with the 50 day average just beneath Wednesday’s close and I’m looking for a bounce.

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So We Got the Bounce. Now What?

Last night I wrote about a couple of my indicators, one of which was pointing towards a bounce being imminent.

Well we got the bounce, so now what? Let’s look at the updated indicators, and I’ll walk through my thinking process.

Breadth 6_3

As I mentioned last night, I use the red line indicator, which is a measure of the number of stocks trading above their 5 day moving averages, to gauge how sustainable a bounce might be.  The indicator bottomed out around 900 or so. A glance back through this year shows that tradeable bottoms have occurred much lower than the 900s. In February, it was 501. In April it was 620 and 459. In general, I start getting excited at any reading beneath 650.

So what does this mean for the next few days?

With the decline line indicator reading neutral at 49, the imminent bounce has been had. The red line did not reach a level which makes me get excited about the possibility of a sustainable bounce. Therefore, my thinking is that I wouldn’t be surprised if the bounce continues, what with Ben Bernanke and all, but I’d be less surprised by a lower low.

Another pattern than I’m watching is that $SPY has been touching down on and then bouncing from the 50 day average, every couple of months.

The one caveat is that today’s candle, a hammer, and on good volume, has traditionally been one of the candle patterns that I trust the most to signal a low. It has been such a strong signal for me that I’m tempted to allow it to override my red line indicator. What’s a few hundred stocks that are not beneath their 5 day moving average when the day’s candle is bullish? I don’t know the answer to that. We’ll have to wait and see.

This is not an exact science. We couple our experience with our data by using our previous experience to help us interpret our current data.

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Short Term Breadth Pointing to a Bounce

And by short term, I mean very very short term. A signal given from this indicator means a bounce is imminent. For this shortest-of-terms measure, I use a bounded decline line indicator, which simply counts the number of declining stocks, compares that number against previous readings over the last 252 days (one trading year), and then ranks this reading against the others in percentage terms. It is bounced because ranking the reading in percentage terms means it is bounded between 0 and 100.

Let’s have a look…Click on the chart to make it bigger.

Breadth 5_31

The decline line indicator (green line, middle pane) is showing a reading of 96.03. Readings in the 90s are typically followed by an immediate bounce, or at the very least, a few days of stabilization. Once the bounce or stabilization occurs, everything resets.

The red indicator in the bottom pane also measures short term breadth but is better for gauging how sustainable a bounce might be. When this indicator gets a reading in the 600s or lower, and the decline line indicator is also indicating a bounce, then I look for bounces that will work for swing trading. In other words, this indicator can help us find bounces that last a few days or more. Since the indicator is currently reading 939, the market has probably not pulled back far enough yet to yield a swing-tradeable bounce.

The bottom line is that I’m looking for a bounce Monday or Tuesday (at the latest) or some stabilization, but expect that this pullback can continue before we get a good tradeable bounce.

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