Calling a Market Top

This post will set out to determine if we are currently forming a market top by identifying current warning signals and by using past examples, most notably the 2007-2008 market.

Calling an exact market top or bottom is fairly difficult and not a task that I aim to succeed at. However, I pride myself on gathering warning signs of a major change in trend whether it is a market top or market bottom. Major tops and bottoms don’t happen overnight and typically take months to materialize. And this is good for the longer term investor – it gives us time to make moves and protect capital.

Mr. Market, as some call it, will give the astute investor plenty of warnings as a major change in trend starts to occur, especially at a market top. The market will likely offer head-fakes along the way and this is all well and good provided you maintain your sell stops and follow rules. It can be frustrating to sell prematurely and possibly buy back-in at higher levels than where you previously sold but that is par for the course: simple money and risk management.

Let’s take a look at 2007-2008.

The market was in a prolonged up-trend from 2005 into much of 2007. The DJIA peaked in July 2007 before dropping quickly to end the summer. It briefly violated the 30-week MA but more importantly, the number of New Lows spiked dramatically, to levels not visited in years (this was a red flag). The NH-NL Diff 10d MA and 30d MA both went negative (July 26th and August 1st, respectively). It was the first time the 10d and 30d Diff had been negative since the previous summer but daily readings were much more dramatic this time around, reaching 500-1,132 new lows. The 1,132 New Lows registered on Thursday, August 16, 2007 was more than Black Monday (10/19/87 when 1,068 were logged – fewer issues on index of course). This was just the first red flag but not an immediate sell signal (watch positions closely, maybe raise some cash to be safe).

2014_10-23_NHNL_Diff_NYSE_2007-08

Following the August lows, the DJIA went on to make new highs in October 2007 and then quickly reversed with another batch of New Lows . The second red flag was the fact that New Highs did not exceed previous levels as the DJIA made a new high, a divergence which is telling. Further confirming this second red flag was the fact that the market once again crashed below the 30-wk MA (November 2007). Please note that the initial red flags span from July to November (4 months = “time”).

The third red flag occurred when the market attempted to re-take the 30-week moving average in December 2007 but failed, as New Highs dipped dramatically and New Lows started to creep back up. By January, the NYSE registered another 1,000+ reading (1,114 on Tuesday, January 2, 2008). By this time, the market had dropped more than 2,000 points or more than 15%. Many individual stocks had dropped much more. Sell stops should have been followed and long term investors should have been accumulating cash by this time. Take profits and cut losses when multiple red flags appear (you can always get back in if the correction doesn’t confirm)!

The fourth and final major red flag occurred after the market rallied in the spring of 2008 yet the DJIA could not overtake the 30-wk MA in April and May. Following this failure, the fear and bad news related to the housing and banking crisis were starting to spiral and New Lows confirmed the damage by reaching the greatest levels ever witnessed on the NYSE, culminating with NL’s surpassing 2,000 on two separate occasions, nearly touching 3,000 on Friday, October 10, 2008 at 2,901. The NH-NL diff 10d and 30d MA went negative on Tuesday, June 10, 2008 and Friday, June 20, 2008 respectively. The NH-NL Diff 30d MA did not turn back to positive territory until Wednesday, April 29, 2009 (essentially as a new up-trend was confirming). The market was still trading above 12,000 in June 2008 so any stragglers could have sold, even at a decent loss at this level. If not, that investor rode the market down to the 6,000’s by October 2008, or another 50% loss (remember, it takes a 100% gain to break even after a 50% loss).

Now, before I am called a Monday morning quarterback, visit these blog posts that I made in late 2007 and early 2008, well before the ultimate crash (the Cramer Post lists additional links from 2007):

01/24/2008: Cramer YELLED Buy, I wrote Sell

10/12/2007: Distribution Day

10/20/2007: Second Major Distribution Day

For a detailed look at the monthly New High and New Low data in 2008 and early 2009, please visit this blog post (some excellent and original analysis here):

Identify Market Tops and Bottoms by Doing this, Guaranteed!

Now let’s take a look at 2014!

The first red flag has been materializing over the course of the entire year: fewer New Highs as the DJIA makes all-time new highs: a divergence that’s telling (remember this from 2007).

The second red flag is the increase in recent New Lows, reaching levels not seen since October 2011 (which was the most substantial correction since the bottom in 2009). Furthermore, the NH-NL Diff 10d MA and 30d MA went negative on September 22nd and October 6th respectively. As of this blog post, the NH-NL Diff 30d MA has been negative for 14 consecutive days and will remain negative for at least another week, based on the figures dropping off and being added to the calculation. It will become the longest consecutive stretch since the correction in 2011 (which lasted 71 days). The 2008-2009 negative stretch lasted 215 trading days (June to April).

2014_10-23_NHNL_Diff_NYSE_2012-14_2

The third red flag and it’s early, is the fact that the DJIA has violated the 30 and 40 week moving averages. The market is allowed to do this during normal corrections but it becomes a red flag when the NH-NL diff is negative with increasing New Lows (which is the case in October 2014).

As of this week (October 23, 2014), New Highs are increasing and New Lows are decreasing but that is normal action as buyers and sellers fight to control the trend. This action is similar to October of 2007 (383 New Highs were registered on Thursday, October 11, 2007). Individual days will swing from time to time so it’s most important to step back and focus on the macro trends that are building.

There you have it: several red flags have been logged here in October 2014 so the caution flag has been raised. Just as in 2007, I can’t confirm a new major change in trend will take place but I can tell you to be prepared and watch for additional red flags and respect sell stops. Remember, you can always buy back in if a steeper correction does not confirm. What you cannot do is make up for a large loss if the market starts to free-fall.

As identified in 2007-2008, these changes in trend take time so we can be diligent in making decisions but we cannot lose sight that the market has given us a warning. Until told otherwise, this market is suspect so I am in the business of raising cash levels. I am not completely out of the market but I have tightened stops and raised cash. Cash is a position and I know I can always jump back in with both feet if an up-trend continues. I’m just managing risk!

Market Breadth: NH-NL Update

A long time favorite blogger of mine, Brett Steenbarger, Ph.D. (welcome back), of the blog Traderfeed wrote a post this weekend that inspired me to post my latest breadth figures.

He stated, in the post: Useful Trading Tools – Part Four: Stock Market Breadth:

“You can see that new highs vs. lows have been waning in the last few days, but also since late December. I am watching this closely, as it suggests that we may be toward the top of a rangebound consolidation period in stocks at the very least–especially given the expansion of new lows during the most recent market drop.”

The Dr. notes that the NH-NL differential has been “waning” and that the breadth indicator may be reaching the top of a rangebound consolidation period for stocks. I don’t disagree but my findings are as such, based on the charts and data below.

Starting with the raw data, we can see that the short term differential and 10-ma Diff are both increasing over the past couple of weeks. Now, they aren’t increasing with great strength but they are moving higher after a short lived “negative period” (highlighted by the pink cells for the Diff and 10-d ma). The longer term 30-d average never went negative during this period. In fact, the 30-d Diff average hasn’t been negative since September 19, 2013 which continues to tell me that the attempted corrections have not gained sustainable traction. Even back in September, the negative readings were short lived. We haven’t had a TRUE sustainable correction, based on this NH-NL breadth indicator, since 2011.

2014_02-23_NHNL_Data

Looking at the basic New High – New Low daily differential chart, we can visually see that NL’s are nowhere near extreme levels and have been weakening since the 2013 peak set back in late June. Additionally, NH’s have also been weakening since their peak in May 2013. To the Dr.’s point, the breadth is also consolidating (similar to a triangle). But, there hasn’t been a major move to either end of the spectrum, positive or negative (the indicator has remained mostly neutral).

2014_02-23_NHNL_Diff

The next chart looks at the NH-NL Diff 10-d MA overlaid on a chart with the DJIA. The power of this chart shows the divergence of the DJIA making higher highs while the number of stocks making new highs vs. new lows decreasing. This resembles the chart the Dr. used in his blog post. Here’s where we can note a minor red flag.

2014_02-23_NHNL_Diff_10MA-Dow

Similar to the chart above, the next chart shows the NH-NL Diff 30-d MA overlaid on a chart with the DJIA. The divergence is even more apparent with this chart and definitely raises a red flag for caution while aggressively trading going forward. It doesn’t mean to stop trading or investing as the NH-NL is still positive and the breadth indicator has yet to show a sustainable breakdown in nearly three years.

2014_02-23_NHNL_Diff_30MA-Dow

Until multiple warning signs appear and the NH-NL goes negative for a sustained period of time (bringing with it the 10-d and 30-d Diffs), feel free to ride the trend by investing and/ or trading in the leading candidates.

Identify Market Tops and Bottoms by Doing this, Guaranteed!

Can major market tops and bottoms be identified with accuracy? Yes, they can! And I will present data that will argue that identifying “major” market bottoms is easier than any other change in market direction. Market tops can also be identified but it’s a bit more difficult than bottoms.

No one can guarantee an “exact top or bottom” but this data will pinpoint an overall change in trend. There’s plenty of time to get out of the market before a devastating fall and even more time to jump on a new up-trend after a bottom.

To support my findings, I will use extensive New High and New Low (NH-NL) data extracted from the NYSE in 2008 and 2009. This data phenomenon is not exclusive to the market bottom of 2009 as studies will show the exact, yes exact, same results can be extracted from every other major market bottom stretching back as far as the NH-NL data is available.

New High – New Low data is historically the most accurate indicator for identifying a major change in trend by highlighting extreme readings and the change in underlying market breadth.

The images contained in this article will identify the following data points:

  1. NYSE New Highs: The number of stocks making New Highs on a specific date
  2. NYSE New Lows: The number of stocks making New Lows on a specific date
  3. New High –New Low Differential: This is simply the number of stocks making new highs minus the number of stocks making new lows.
  4. NH-NL 10d Diff: This is a simple 10-day moving average representing the number of stocks making new highs minus the number of stocks making new lows.
  5. NH-NL 30d Diff: This is a simple 30-day moving average representing the number of stocks making new highs minus the number of stocks making new lows.
  6. NH-NL % Ratio: To calculate the percentage correctly, use this formula: (New Highs – New Lows) / (New Highs + New Lows) * 100 = X%
  7. NH-NL % Ratio 10d Ave: This is a simple 10-day moving average representing the percentages listed in the column terms #6 in this list

I follow the progress of stocks making new highs and new lows on the NASDAQ and NYSE and pay specific attention to turning points in the differentials and ratios. I am particularly interested in the extreme highs and lows of the readings, especially after a long trend, as they start to drop hints of an impending change of trend (positive to negative and negative to positive).

The image below shows that New Lows had dominated the market for nearly 18 months when extreme readings started to appear in October 2008. In fact, the readings in October 2008 were the most extreme that my NYSE NH-NL data contains which goes back to the early 1980’s.

010509_NHNL_wkly_18months

October 2008 NH-NL Readings for NYSE:
2008_10 - October

As the second image shows, the daily New Low readings were well above 1,000 with a peak of 2,901 on Friday, October 10, 2008. The market was screaming exhaustion as the selling pressure of the past 18 months was hitting its max. All other readings were in extreme territory including the basic NH-NL differential, the 10d & 30d differentials and the % ratio. The extreme readings continued through the end of November 2008 when they final subsided in December but remained negative.

November 2008 NH-NL Readings for NYSE:
2008_11 - November

December 2008 NH-NL Readings for NYSE:
2008_12 - December

Heading into early 2009, “blood was running in the streets” as Baron Rothschild once declared and most investors had been knocked to their knees while two of the most prestigious investment banking firms in America disappeared. The greatest value investors of all time state that the best time to buy is when this type of extreme environment occurs. The problem with that statement is that it’s based purely on fundamentals and I just can’t blindly jump-in and grab shares without some form of technical guidance. Think about that for a second, blood had been running in the street for the duration of 2008 so I suspect that many value investors were buying and saw more pain before the market decided to turn. Buyers in early to mid 2008 had to endure quite a ride before the market turned up in the spring of 2009. I prefer to catch a trend on the up-swing, not the bottom; besides, pinpointing the exact bottom is virtually impossible.

January 2009 NH-NL Readings for NYSE:
2009_01 - January

Bernard Baruch was quoted as saying: “Don’t try to buy at the bottom and sell at the top. This can’t be done–except by liars.”

January 2009 was much like December 2008 as the market remained negative. Then in February 2009, the market dropped again as the NH-NL readings started to head back towards more extreme levels. However, they didn’t reach the levels of October 2008 so this signified a “higher low” for the readings, a second clue that the market may be looking to reverse direction.

February 2009 NH-NL Readings for NYSE:
2009_02 - February

NH-NL Readings making higher lows for NYSE:
040609_NH_NL_trend change

March 2009 was the turning point. The extreme readings subsided (light red and dark red readings on my graphics) and the FIRST positive reading was registered since May 2008 (represented by “blue figures” on my graphics). On March 26, 2008, the NYSE logged a reading of 10 New Highs and 0 New lows, the first time a “0” New Low reading was logged since February 27, 2004. By contrast, the NYSE logged 11 additional days with “0” New Lows in 2009 and 20 days with “1” New Low for that same year. The year 2008 had one day with “1” New Low and the years 2005, 2006 and 2007 had zero days with “1” New Low. Amazing stats!

[Read more...]

Market Bottoms: Using New High & New Low Extreme Readings

The New High – New Low ratio (NH-NL) has been very accurate over the years when it comes to forecasting major and/ or pivital market lows. It typically logs extreme readings when the market is exhausted. That makes complete sense because most market participants have exhausted all the selling from their portfolios and holdings.

PLEASE CLICK THE IMAGE TO SEE FULL SIZE GRAPHIC:

I can’t confirm that the recent extreme readings of the past week are forecasting a market bottom until the NH-NL ratio turns positive again. The key, please pay attention, to these extreme readings is when it is followed up by the ratio venturing back into positive ground! See the blue arrow examples on the chart. This confirmation signals a MAJOR market reversal.

When that happens, that’s when the confirmation for loading up on equities is ringing loud and clear. But, you may ask, how do we jump in earlier than this confirmation because a good portion of the move is already underway when this finally takes place.

Well, you look for a market reversal within one or more of the major market indexes along with a follow-through day, roughly 4 to 10 days later. A follow-through consists of a major index such as the $COMPQ, $DJIA or $SPX advancing 2% or more on volume larger than the previous day, preferably above average as well. When two or more major indexes follow-through, the signal to start initiating positions has arrived.

Tuesday was day 1 for the most recent “attempt” for a market reversal (even if it’s only short term). We now wait patiently before taking new positions for a follow-through day, beginning tomorrow (day 4).

Stay tuned to see what happens. I am sitting in cash waiting for a signal.

Market Overview: Identifying a Change of Trend

Standard & Poor’s said it downgraded the U.S. government’s credit rating from AAA to AA+ because it believes the U.S. will keep having problems getting its finances under control and pointed to the lack of leadership in Washington. Per Yahoo Finance: “The Obama administration called the move a hasty decision based on wrong calculations about the federal budget. It had tried to head off the downgrade before it was announced late Friday.”

Politicians lie and markets do not so ignore Washington and focus on PRICE and VOLUME action!

So, with that said, what does last week’s action across the US and global market truly mean? The $DJIA was down 5.75% on the largest volume since last summer, the $COMPQ was down 8.13% on the largest volume since May 2010 and the $SPX was down 7.19% on the largest volume since May 2010.

All three major markets confirmed a Dow Theory Reversal, a “Change of Trend”. In addition to the major indexes, the Dow Transports TRAN also confirmed a Dow Theory Reversal by breaking support and making a lower low.

Emotionally, I suspect that the market will bounce and that many stocks and indexes are “oversold” but this will most likely only be short term. Long term, the trend HAS CHANGED according to the charts. And until the charts show a new trend to the upside, all moves up are suspect. No one has to pick the exact bottom or top of a market so be grateful to recognize a trend and grab 60-80% of the move. It’s a lot safer and less risky to jump on board once the trend is confirmed rather than play a guessing game that can get you caught in a 500 point slide, similar to last Thursday. Markets can change on a dime so be prepared at all times but longer term trends stay intact for months, if not years.

I made a mistake in my general market analysis by not paying enough attention to my New High – New Low (NH/NL) Indicator. And it cost me because I put on positions in $RENN and $DANG in recent weeks after warning signals had been given. I did avoid a new position in $LNKD and saved money heading into the earnings announcement. Overall, shame on me but I didn’t lose too much because rules were followed and I am digging deep to listen to my indicators. Regardless of what “ I think may happen”, I am listening to my indicators and charts 100%!

So you ask: What warning signals?
The first signal was given by the Dow Jones NH/NL 10-day average differential (Diff) (chart above). The 10-d Diff started to make lower lows as the Dow was making higher highs, a clear divergence that warns the underlying stocks are weakening while the overall market is making a new high. This one signal alone should have put me on caution while entering new positions. It didn’t because the NH/NL 10-d Diff was still above the critical level of zero. Well, the market took care of that this week by plunging below the zero level, closing at -203 on Friday for the Dow. Consider this, it closed at +15.1 last Thursday ( 7/28) but went red the following day at -2.5 (last Friday, July 29, 2011). The divergence and the reading below zero was now screaming MOVE TO CASH and gave us enough time to do it before the end of the week romp! We all had time to get out without taking a loss. As it stands now, the 30-d Diff is also below zero with a reading of -21.47, the first reading below zero since July of 2010.

It’s interesting that the markets topped in May, just as Osama Bin Laden was killed – I must give a HT to Howard Lindzon for coining the Osama Bin Laden Top (he may have nailed it) and closing his blog post with this statement:

With the mood of financial markets quickly turning negative, the horrific price action of financials, the silliness of IPO valuations and some Bitcoin mishigas, you may not soon forget the ‘Osama’ top.

Now, let’s take a look at a number of charts and see what they “were” saying and what they “are” saying right now, as we head into next week (ahead of the market reaction to the US credit downgrade). NOTE: I personally believe that the downgrade is mostly priced into the market but I am sure we will still see some further selling pressure before a normal bounce.

[Read more...]