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In
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Over the last
couple of months we've introduced two related tools that we use on a regular
basis to spot the market's true undertow.... TRIN (or the trading
index), and a comparison of breadth and depth trends. We're not
going re-explain them today - we've done that plenty already. Instead,
we're going to take one of those tools 'up a notch'.
 In
other words, what you've seen so far is 'Market Trends 101'. Today we're
going to begin Market Trends 201 with the same tools.
Oh, and
just so you know, it's no coincidence we're doing this today - Thursday's
wild ride and today's post-pullback action is screaming for attention,
as the depth and breadth data went off the charts..... literally. Though
these clues were bearish a few days ago (and accurately so), as of yesterday,
rare-but-telling levels were reached for up/down volume as well as advancer/decliner
levels.
Let's just say
this is where interpretation becomes an art rather than a science. (Proper
interpretation is also where the big money is though, so.... )
OK,
a brief revisit of the technique is in order, just to make sure
we have a perfect understanding of what we were trying to do with breadth
and depth before we turn it completely around.
 When
we say 'breadth', we're referring to the number if advancing stocks for
any given exchange (usually the NYSE, for us) compared to the number of
decliners. The daily data itself is too erratic to use, but a moving average
of the advancers and the same moving average of the decliners shows us
the true 'trend'. If the advancer moving average is pointed upward while
the decliner moving average is pointed downward, that's bullish. When one
moving average moves above the other, that's an outright signal of a new
trend.
The 'depth'
analysis considers the 'up' volume against the 'down' volume. Other than
that, the interpretation and application is idential to breadth;s. On the
nearby chart, you can see how this technique spotted the recent dip a few
days before things went from bad to worse.... the bearish (red)
moving averages moved above their bullish (green) counterparts.
[If you want
more than the crash course in how we examine breadth and depth though,
we strongly encourage you to read our March
25th explanation.]
So how do we
turn this basic indicator into an advanced indicator?
For the sake
of simplicity, we hadn't brought this up yet. Considering it became
relevant yesterday though (and considering a major reversal is hanging
in the balance) today's a perfect time to unveil another way of
looking at breadth and depth.
In simplest
terms, they can also be used as 'excess' and reversal-spotting tools.
 The
premise is simple enough. - too much of anything is too much....
the market doesn't like to operate at its extremes for very long. This
includes persistent up volume or down volume, and persistently high advancers
or decliners; the moving averages of these data sets tends to reach peak
and trough levels right at major market turns.
And how high
is 'too high'? That's the tricky part, and the reason we consider this
more advanced use of the tool to be an art more than a science.
Breadth and
depth values that are 'too high' are like good art - you'll know it
when you see it. As an illustrative example though, yesterday's peaks
in the moving averages of both bearish depth and bearish breadth were in
line with the peaks seen at prior major bottoms.
It's no real
secret that stocks have been sinking over the last four weeks. What may
be more difficult to see is that the total selling volume we've seen from
the NYSE over the last four weeks has averaged over 1 billion shares per
day (1.047, to be precise). To put that into perspective, we haven't
seen selling that persistently heavy since the average reached 1.07 billion
per day back on March 9th of 2009..... the day the bear market ended.
We also saw
an average of 1.1 billion 'down' shares back on October 27th of 2008, right
before a 10% bounce. Back on August 16th of 2007, we saw a huge four-week
average of 1.37 billion in the NYSE's daily down volume, after a month's
worth of selloff. Two months later, the S&P 500 had gained 9%.
(Click
here for a long-term, full-screen shot of a moving average of the NYSE's
'down' volume compared to the S&P 500.)
Get the idea?
These
are blowout days that shake the last remaining sellers out of the market
for a while. And it's not just the NYSE's down volume trend that moves
to these extremes.... most of the breadth and depth trend measures reach
levels seen only every few months, if that, on blowout days.
So are we
saying this sudden surge in the NYSE's average down volume is a bullish
clue? Basically, yes. There's a caveat though.
 The
hard part about assuming a peak has been made is the fact that these trends
may still be on the rise - the peak will come later. That could
certainly happen now too, up-ending the "enough is enough"-themed
call.
Given the whole
risk/reward scenario and current market condition though, odds are better
than average that Thursday was indeed the peak in berish breadth
and depth.... the exhaustion. From here, we should see bearish breadth
and depth taper off while bullish volume and breadth start to swell again.
One of the key
clues to such a stance lies in the fact that yesterday was one of the worst
days we've seen in months. The market generally doesn't let chaos go uncorrected.
(It will let the market bleed to death slowly, but it's rare for a price
shock like that one to not be reversed at least for a while.) And,
the fact that the blowout day occurred after a prolonged move lower
is part of the equation; we wouldn't be preaching this sermon if these
clues had emerged in late April while stock were still on the way up.
Bottom line?
When
you start to see things you only see about once a year - as we did
- big changes are usually brewing.
You can add
the VIX, TRIN, and a whole army of similar market barometers to the list
of indicators reaching extremes yesterday as well.... they all reached
their limits, and hit relative levels generally seen at market bottoms.
We'll keep an
eye on the market all the same, and keep a short leash on the call. By
this time next week though, we expect to see the bulls on even-firmer footing.
Stay tuned.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
