Over the last few weeks we’ve made a concerted effort to illustrate how reversals tend to occur right as the market’s dynamics (breadth, depth, and sentiment) hit extreme levels, or right after the market’s undertow has already given subtle but reliable signals. Today we’re going to share another ‘tell’ that signals pretty infrequently, but has tremendous accuracy at spotting the market’s significant tops and bottoms.

First though, a quick reality check that using such tools does indeed work.

Remember the big crash from the 20th? How about the ‘flash crash’ from the 6th? Yeah, well, just for the record, this was a possibility that we spotted - or the VIX spotted, technically - back on April 30th. The underlying risk, however, had been hinted by the TRIN moving averages back on May 8th. The plunge from the 20th (and really, from the 17th on) was correctly signaled by breadth and depth trends.

We’re not saying any of this to boast; we have the ability to be wrong. We’re only pointing this out to verify that proper use of the tools (and the market data that nobody else is considering) can and does work.

With that in mind, there’s one last weapon we want to add to the arsenal today… one we don’t get to use very often, simply because it’s a rarity to see it ’signal’.

Along the same lines as the ‘extreme’ spotting use of breadth depth, TRIN, and the VIX,  the number of stocks hitting new highs and new lows on any given day can also indicate that, or when, a trend is exhausted and a reversal is nigh.

We’ve actually seen consistent success in using the NYSE’s new highs and lows as much as the NASDAQ’s new highs and lows. So, to illustrate the usefulness of either, we’ll show you both.

In simplest terms, when the number of new highs or new lows reaches levels only seen once or twice a year - and usually levels observed at prior major bottoms and tops - then something has got to give, because that wild degree of bullishness or bearishness can’t be sustained. In fact, that pressure generally needs to be bled off by, you got it - a reversal.

Take the NYSE’s new highs and new lows as an example. The figure approached 500 three separate times since October of 2009, and though it took a while for the third instance to turn into a major pullback, all three instances did indeed materialize right at or right before major tops. Take a look.

A simple visual scan of the data could have told you something wasn’t balanced in October, January, and April. However, if you slide further back on the chart, you would have also found that NYSE new highs in the 400/500 range (like we saw then) typically occurred at the end of rallies, and the beginning of pullbacks.

Likewise, ‘too many’ new lows are common at major bottoms, like the one we saw thanks to the ‘flash crash’. Sure enough, the market bounced the next few days. We can now see something of a bullish effort today, following yesterday’s 133 new lows…. an extreme number, under the current circumstances. [In a bear market, an extreme number of new lows might be several hundred. This isn’t a bear market though.]

The risk one runs here is that 133 new lows might seem like a lot - and a peak - today, but we may see 233 new lows tomorrow. Welcome to trading…. it’s not risk free. Generally speaking though (i.e. historically), the odds of back-to-back skewed numbers are pretty low.

In other words, yes, we think the surge on the number of new NYSE lows yesterday was indeed a clue of a major bottom being made.

Though it’s not a lot different, here’s a look at the NASDAQ’s equivalent data. Obviously 178 was too many new lows to stay bearish back on the 6th. It probably is this time too. [That said, a consistent reading of several hundred new lows isn’t unheard of in the nastiest part of a bear market. Remember, its all relative.]

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We’re not going to dive into the complete explanation again ….we’ve already explained the chart (and its value) plenty in the blog lately. We simply want to post an update of the breadth and depth comparisons, because they’ve each turned bearish - via crosses of their moving averages - within the last week. And, Monday did little to stop that bearish trend in its tracks.

In fact, Monday was anomaly worth dissecting.

While the NASDAQ closed higher (up 7.38 points, to 2354.23), we actually saw more decliners than advancers…. 1315 to 1415.

How does the index make progress with more losers than winners? Two reasons. The first one is, ‘up’ volume was grater than down volume… 1.4 billion to 980 million. The second reason is, the large caps in the cap-weighted index did most of the heavy lifting.

While it worked for the bulls on Monday, it’s not a scenario that offers hope for a lot of longevity - most of the Composite’s stocks need to participate in a rally if it’s to have nay staying power.  Besides, the breadth as well as the depth trends over the last three weeks (and it’s the trend that matters most) are still decidedly tipped in favor of the bears.

Until the green lines move back above the red lines, any rebound effort will remain suspect.

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While the market may ‘feel’ oversold by now (and is in most short-term senses), in the bigger, longer-term picture, the NYSE’s long-term TRIN moving averages says we aren’t quite at the ultimate bottom yet.

Below is an update to the NYSE TRIN chart we last looked at on May 8th…. a short-term (red), intermediate-term (blue), and long-term moving average of the Trading Index daily data. As you can see, in the short and mid-terms, we are indeed oversold and ripe for a bounce - the moving averages are well above their upper limit. The long-term average of the TRIN data, however, is not yet up to its upper Bollinger band yet. As such, the breadth/depth disparity is not quite adequate enough to suggest the downtrend is totally spent.

Take a look; we’ve got some last thoughts after the chart though.

We’ve mentioned this a great deal lately, but it bears repeating now - this environment is one in which you’ve got to think in multiple timeframes, and accept the fact that the market can be going in different directions depending on the timeframe in question. This TRIN tool continues to be an effective way to keep tabs on what the undertow looks like for each of those timeframes.

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We posted a bullish/bearish outlook earlier today based on the NYSE’s TRIN data, but we also want to follow up with one of the other key market barometers we’ve been following of late…. straight-up comparisons of bullish volume to bearish volume, and the number of advancers to the number of decliners. As was the case with the TRIN indicator, the raw volume and advance/decline data s too erratic to use; we’re looking at their moving averages instead. [For the complete background on the breadth and depth analysis, go back to our explanation from March 25th.]

So what finally happened? As you might have guessed, what had been marginally bullish suddenly became decidedly bearish in the latter half of last week. The decliner trend overpowered the advancer trend, and the bearish volume trend overpowered the bullish volume trend. It’s quite clear on the chart of both below.

So now that it’s done, we’re bearish? Basically, yes…. at least until, the bullish (green) lines crawl back above the bearish (red) trend lines. Bear in mind, however, that in our TRIN commentary we already noted the market was so oversold in the short run that a near-term bounce was in the cards. This breadth and depth chart above is better suited for longer-term trading, and may well stay bearish all throughout any brief rebound effort. (Timing is still everything, and speed is sacrificed for certainty….. the short-term/long-term trade-off.)

As before, we’ll update this chart as merited.

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A lot can happen in a week…. clearly. While the market was seeing a little turbulence two weeks ago, it was nothing out of the ordinary, and certainly nothing that suggested the long-standing rally was in jeopardy. The 6.4% dip last week caught many investors with their pants down, reminding them to assume little, and never stop playing good defense.  

So what’s next? More of the same torture, or are the bulls ready to stage their rally? How about a mix of both, depending on the timeframe?

We took a look at how to the use an exchange’s Trading Index - or TRIN - back on April 2nd. At the time, we observed how a long-term moving average of the NYSE’s Trading Index was approaching dangerous overbought levels, and that a pullback was around the corner. The market peaked about a week and a half later, right around the same time that long-term TRIN average hit its lower Bollinger band and started to move upward again. And now, it’s clear the S&P 500 started to wave red flags of this rollover about the same time.

Not that the TRIN data and its interpretation isn’t without its inherent problems (namely, inconsistency), but in this case we can see its predictive power… especially if used in conjunction with other tools.

So what’s the NYSE’s TRIN reading telling us now? It’s time to add some layers of detail to the tool.

While we first used it as a long-term reversal spotting tool, by shorting the moving averages of the TRIN data, we can use it as an intermediate-term and a short-term trading tool as well. On the chart below, we’ve done just - the TRIN’s short-term average is the red line, and the intermediate-term average is the blue line. And, like last time, the long-term average is the green line. The interpretation doesn’t change though…. an excessively-high reading (for any timeframe) is actually bullish, and an excessively low reading (for any timeframe) is bearish.

With that in mind, take a look at all the NYSE’s TRIN averages, as of Friday’s close.

See anything interesting? If you see the short-term and intermediate-term TRIN averages as being too high [and back up to known ‘extreme’ levels that tend to coincide with a market bounce], then you’re right.

What this means: In the short run, the market is due for a bounce. Makes sense. Last week’s pounding was heavy, and possibly overdone. When the red and blue lines below start to point lower again, that will likely mean the end of any dead-cat bounce.

Longer-term though (the green line) we can see the long-term TRIN average is just now starting to move up and off its bottom, telling us the bears aren’t anywhere close to done yet in the grand scheme of things. Only when that line hits its upper band line will the needed ‘bigger-picture’ breadth/depth balance be found. Until then, the overarching pressure should be bearish - the short-term bullishness will only be a blip (though possibly trade-worthy).

While most traders tend not to think in multiple timeframes like this, they should. Understanding where the high and low spots are within a longer-term trend, in addition to knowing what the true trend actually is, can save and make a small trading fortune.

We’ll follow up with this chart - in all three timeframes - as needed in the future.

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