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.

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.

The first chart that I would like to explore is the percentage of stocks trading above the 50-day moving average on the S&P 500 Index. Oversold conditions typically appear when this indicator drops below 20%. We last saw multiple readings under this level back in May, June and July of 2010, the last time the market traded below the 200-d ma. The reading closed at 3.6% on Friday, the lowest level since the 2008 market correction. This says that the market is oversold and is due for a bounce which may be the case but keep in mind that readings below 20% can exist for months at a time with short term rebounds. So, I see this signal as short term for now, considering the Dow Theory confirmations and the NH/NL readings. We will bounce higher but the other charts are signaling a longer term correction until told otherwise!

This chart shows the NH’s and NL’s added together to give us the daily differential. Friday registered the most new lows since November 21, 2008 when the reading spiked to 1,527 (historically low territory). The NH/NL ratio is best used to tell us when the market is changing trends rather than picking the tops and bottoms of markets. The NH/NL ratio has been mostly positive since March of 2009 so the readings of the past few days are red flags as the strength among the individual market participants is weakening considerably.

The NH/NL 10-d Diff is the average of the daily calculations over the past ten days. This 10-day average allows us to view the market action with less volatility than the daily fluctuations. The chart clearly shows us that the NH’s have weakened considerably since 2010 but did make a new high in February of this year. However, that new high was short lived and never quite made it to the peaks of 2010. The red arrow shows us that the NH’s have been trending downward for the past 18 months but most importantly, the peaks have been coming up short from March, to May to July.

NASDAQ CHARTS:
Similar to the Dow Jones NH/NL chart, this NH/NL chart of the Nasdaq is also racking up new low statistics, the most since March of 2009, the beginning of the bull market. What does this tell me: it tells me that the market may be turning since the readings now mimic the start of the up-trend. Short term, we’ll bounce around but watch the NH/NL 10 & 30-d Diff charts to avoid the daily noise.

The next three charts reinforce the action that we are seeing on the Dow Jones. Trend changes can be taken more seriously when two or more of the major indexes confirm the same action on the charts. We have all major indexes flashing the same signals: NH’s weakening, NL’s increasing, Dow Theory Reversal confirmation and distributions days and weeks on big time volume.

One last signal to watch is the action on the Value Line Index (VLE) which was featured in the post What Should We Do, written on October 27, 2008 when the market was hitting new lows. This indicator was down 9.62% last week, a clear sell signal.

The Four Percent Model Indicator uses the Value Line Composite Index (I use the Value Line Arithmetic Index (EOD) or symbol $VLE on StockCharts.com), which can be found on the web or in financial pages of newspapers. The model makes use of the weekly close of the Value Line Index. A buy signal is generated when the index rises four percent or more from the previous week. Similarly, a sell signal is indicated when the index falls four percent or more from the previous week.

I leave you with this: If the trend (this article and analysis applies to the longer term trend, not for day and swing traders) has truly changed for good and does not have the stamina to reverse back to the upside, be careful but understand that this is only the beginning. You still have time to get out before further damage to your accounts. We will have a bounce or two so use them wisely but don’t stay or go long if the Dow Theory doesn’t reverse the trend back to the upside. You have been warned, not by me but by the price and volume action of the market!

However, this clear distribution is giving us a message. What is that message?

Well, just as follow-through days signal the potential start of a new rally (uptrend), five or more distribution days within a few weeks (on above average volume) is starting to hint the rally is coming to an end.

It’s clear that the uptrend has halted its continuous trek to new highs while the odds favor that the market is heading towards a correction.

So, what do you do?

Immediately assess each of you individual holdings and start to lock in gains on stocks churning (no longer making new highs). You don’t have to sell the entire position but it may be a good idea to scale back and definitely get off margin if you are employing leverage.

As mentioned in a previous post, Market Reversal? View the NH-NL Ratio, the NH-NL ratio is the strongest secondary indicator on the market for a major trend reversal. The NYSE registered its first negative reading since November 16, 2010. The NASDAQ has registered its first multi-day negative readings since November 16-17, 2010. The overall 10-day MA differential for both indices is still positive but a move to negative territory will be the major confirmation.

Price and volume tips you off as the main indicator while the NH-NL ratio confirms the longer term trend reversal.

If following items confirm, I highly suggest that you move to cash and avoid the risk of losing recent gains or start to show a loss.

• 5 or More distribution days on multiple indices within a few weeks
• Index price moves below the major moving averages (50-d and 200-d MA)
• New High – New Low 10-d MA Diff turns negative
• And most important: your individual holdings are making lower lows and lower highs while slicing major moving averages

Nothing is guaranteed in the market but when distribution days pile up (in a short period of time), it’s time to take notice, lock in gains and look to move to cash if all support and confirmation indicators confirm.

Let’s keep an eye on the NASDAQ, DOW and NH-NL ratio.

Let’s ask the NH-NL ratio, considering it has been “spot on” for every major market reversal as far back as the data started to be gathered (decades). Until the NH-NL ratio reverses, don’t consider any reversal sustainable: history speaks for itself.

Watch the NH-NL daily and weekly readings, the entire story will be told here (NO other indicator is necessary).

Only one other date surpasses Friday’s total: Monday, October 11, 1982 when the DJIA closed at 1,072.79. The market recorded 653 NH’s, 7 NL’s, 1,504 advances, 292 decliners and “up” volume outpaced “down” volume by an almost 10-1 ratio.

The NASDAQ closed at 202.31 on the same day with 418 NH’s, 14 NL’s (not even in the top 10 for the highest number of NH’s ever recorded). Do note this: the highest NASDAQ reading ever came later that year on Thursday, November 4, 1982 with 525 NH’s (following that week’s election day).

So what does this all mean? Well, by mid-1983, the market surged higher by 20%. It continued to move higher until the crash in 1987 but long term, the market is up well over 10-fold since this NH extreme.

How about today’s market? I can only tell you this: we are in an up-trend as of today and until the market breaks that trend, do not try to “guess” when it will reverse.

I have my “opinions” of the market but as you all know, we must trade what is actually happening, not what we think should be happening. Yes, I am concerned the market would like to correct longer term based on poor economic policies, tremendous debt levels, a depreciating dollar and most important: possible inflation. But, until we get the true catalyst, trade what the market is telling you.

The 634 NH’s represents an extreme in the market and I will be watching for further catalysts. How long can this market sustain higher stock prices based on faulty growth? You can only take so many cash advances on your credit cards without paying before they cut off your borrowing capacity. Maybe I have it all wrong but I am concerned long term. Short term, the market is higher unless it says otherwise.

I leave you with this: the vast number of “gap-ups” in stocks making new highs concerns me. Do they want to fill? If so, we will have an almost endless supply of high quality shorts to trade.

Chart provided courtesy of www.Decisionpoint.com

NASDAQ All-time
This first table shows us that seven of the top ten days with the most new highs came during the bull run of the 1990’s. The top day, Thursday, November 4, 1982 gave us the most NH’s all-time for the NASDAQ with 525 (only 13 new lows). The NH/NL 10-d MA Diff was 222, the NH/NL 30-d MA Diff was 196, the Adv-Dec Ratio was 1,087-469 and the NASDAQ closed at 225.01, up 1% for the day. The stock market bottomed on August 12, 1982 and rose 35 percent by the end of the year as we can see in the powerful NH/NL ratio averages listed above. The NH/NL 10-d MA Diff switched from negative to positive on Thursday, August 26, 1982 and never looked back (the tally was 180-15 that day); this was also the first day the NASDAQ NH/NL Diff popped above 100 since May that year. Talk about a market timer.

NASDAQ – 2009
The list from 2009 is freshest in our minds because it’s present day data. All but one of the top ten NH days for the NASDAQ happened last month with the 10th day happening at the end of June. It’s interesting because the ratio is getting stronger but the leaders aren’t cooperating and we aren’t “blasting-off” with 200 & 300+ NH’s as we did in the 1982 bull, the 1991 bull, the 2003 bull or the bulls of the mid and late 1990’s.

NASDAQ – 2008
We only logged three days above 100 NH’s in 2008, enough said. If you didn’t sell your long holdings and were still trying to pick a bottom, pay attention to this data next time; you won’t get hurt so badly!

NASDAQ – 2007
The NH/NL moving averages sunk deep into the red by the fall of 2007, giving every investor the opportunity to lock in gains and prepare for the ensuing bear market. I’ve already “tooted” my own horn for writing multiple blog posts to lock in gains on this site in late 2007 and early 2008 (see here: Calling Tops and Bottoms: Trend Changes). More articles are listed below. The NH/NL 10-d MA Diff went negative on Tuesday, October 23, 2007, 10 trading days before the NASDAQ’s ultimate top. The index went on to drop more than 40% in one year and 55% to the bottom. Once again, pinpoint accuracy for the NH/NL data.

List of articles on NH/NL Data:

• NH NL picks Market Tops and Bottoms
• Calling Tops and Bottoms: Trend Changes
• New High New Low Data
• Market Breadth
• New High New Low (NH-NL) Chart

NASDAQ – 2006
Not much to talk about in 2006 – it was an average year with ups and downs but nothing drastic and not too much trending using this indicator. A drop in the markets took place in the summer of ’06 which the NH/NL’s picked up.

NASDAQ – 2005
This year was similar to 2006 as the NH/NL data was fairly quiet with no extremes in either direction.

NASDAQ – 2004
This year’s NH/NL data started off extremely strong with the second highest NH daily total ever for the NASDAQ. Nine of the top ten NH days came in January as the bull market of 2003 (recovery from bubble burst) was coming to an end. The market reached a top in January and didn’t surpass these levels until the following winter. January of 2004 gave us 6 days with a NH/NL 10-d MA Diff above 300, 5% of the total number of times this has happened to the NASDAQ over the past 30 years (128 total times).

NASDAQ – 2003
The bull market of 2003 gave us some of the strongest overall (average) NH readings of all-time. Wednesday, September 3, 2003 is the 8th highest daily total ever (only 2 NL’s that day for a 99% NH/NL ratio rating). The NH/NL 10-d MA Diff turned positive for the first time on Wednesday, March 26, 2003 while the NH/NL 30-d MA Diff turned positive on Tuesday, April 8, 2003. The up-trend started in March and blasted off in April, once again proving that the NH/NL data is pinpoint accurate – better than any stochastic, oscillator or other market tool available. We can’t argue with history.

In closing, the difference between the past turning points and 2009’s turning point is that the former up-trends quickly showed many consecutive days of more than 100+ NH’s, soon to be 200+ NH’s per day. This year has failed to do that time and time again. Until it does, we’ll wait patiently and continue to watch the data, looking to pounce on the signal!

I hope you enjoyed this historical and educational post. If so, follow me on twitter for my nightly and weekly updates (the NH/NL data is the majority of my focus along with individual growth stocks): Follow Me On Twitter

Don’t forget to subscribe to my free blog feed so you can get my blog updates e-mailed directly to you or listed on your RSS home page.

As I said in the post NH NL Picks Market Tops and Bottoms:

Consistent Nasdaq readings above 100-200+ will be the official confirmation to grab and add shares for trend traders!

That’s what I am looking for! Until that happens, a “true” up-trend is not sustainable. The up and down whipsawing of the past several month is what we can continue to expect until we see consistent readings in the triple digits.

Well, you don’t need a crystal ball, you don’t need any Wall Street guru’s, you certainly don’t need fancy computer software and you can simply ignore the talking heads. It’s that easy. Maybe we won’t pick absolute tops and bottoms but we can identify trends as they begin to develop.

You just need to follow the action among the individual stocks in the market! Learn to focus on the number of stocks making new highs versus the number of stocks making new lows. It’s been the true crystal ball in my method since I started to turn a consistent profit in 2002. It’s the backbone of my trend following methods.

The NH-NL Differential is simply the number of stocks making new highs minus the number of stocks making new lows.

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 differential. I am not so interested in the extreme highs or lows of the ratio but rather changes in trend from positive to negative and negative to positive over a period of time.

The yearly Nasdaq New Highs and New Lows (Differential) are captured in my charts below, dating back 10 years. With many market pundits (or talking heads) saying that we may have reached a bottom, I felt it was time to do some homework and study the past charts so we know what to look for in 2009. It is true that the trend seems to be changing but we aren’t quite there yet. Focus on 2002 and 2003 to get an idea of what we may see if this market decides to make a true up-trending run, one that’s sustainable.

Consistent Nasdaq readings above 100-200+ will be the official confirmation to grab and add shares for trend traders!

The chart highlights in red where I was making the sell posts (the articles are listed below):

Anyway, I have been posting twits about the strengthening of the NH-NL ratio which is starting to tell me that the newest trend change is beginning. Yes, this is my first major blog post saying that my screens (market tools) are telling me to wake up because things are starting to change. It’s not time to jump in with both feet and buy every stock that’s up on above average volume but it’s time to sharpen the skills and be ready. We may look back and point to March and April of 2009 as the bottom of the market or at least the start of the changing trend.

We don’t have market leaders yet but when they appear, I will locate them, post up charts and talk about them nightly on twitter (twitter.com/cperruna). Too many stocks still have their 50-d moving averages below their longer term 200-d moving averages and new highs are still limited. However, new lows have dried up considerably and the NH-NL ratio has a moving average that is trending higher for about a month now. That’s the most sustainable trend for this ratio since the big decline started.

Stay tuned to the blog and my twits for follow-ups to my research on individual stocks and the overall trend.

In the meantime, take a look back at the numerous blog articles I posted in 2007and 2008 talking about a market decline, shorting stocks and selling in general. Learn from what the simple tools were telling us. I am far from a market genius and far from rich but I can make a few dollars following the leaders and the NH-NL ratio.

A Review of Articles Pointing to a Stock Market Decline in early 2008:

• May 23, 2008: Smelling Trouble
  

  The bottom line or point of today’s rant is the fact that I still feel that the market is headed for a decline or as I phrased it a couple weeks ago: The Big Decline (long term perspective of course).

• May 8, 2008: Market Distribution
  

  I originally started to point out market troubles back on March 14, 2008 in a post titled Snapshot Friday; I highlighted both the Dow Jones and NASDAQ with clear yellow shaded areas showing the 200-day moving averages pointing down for the first time since 2003 (that’s huge if you ask me).

• May 7, 2008: The Big Decline
  

  I am a positive person by nature and I prefer to buy stocks going up but I am starting to see several leading stocks struggle to hold new highs or fail to challenge recent highs. These patterns are familiar and they are suggesting that the recent bounce is the final stage before a possible market decline.

• January 23, 2008: Setups for Selling Stocks Short
  

  I wrote an article on October 15, 2007 titled How to Make Money Selling Short, precisely when the general market indexes were topping. I am not going to take full credit but subconsciously my charts were giving me signals that the market was showing the major red flags and signals of what we are seeing today.

A Review of Articles Talking about Selling, Profit Taking and Market Distribution in late 2007:

• 10/03/07: Is Shanghai a Nasdaq Déjà vu
  

  Well, the current two year rise of the Shanghai Stock Exchange Composite Index looks remarkably similar to the rise of the NASDAQ of the late 1990’s and the charts below explain better than I can!

• 10/04/07: A Technique for Profit Taking
  

  What do you do in a market like today when you have profits in multiple positions but you don’t want to give it all back? You want to continue to ride the winners but at the same time, you want to maintain the unrealized gains in your account. HOW?

• 10/12/07: Distribution Day
  

  This was the largest showing of volume in two months and is not healthy because it was pure distribution. It was only the second distribution day over the past month so we can’t call this a bear run but please be on the lookout for a possible correction of 5%-10%. Technology stocks led the decline as BIDU gave back 10% of its amazing run.

• 10/15/07: How to Make Money Selling Short
• 10/17/07: Inverse ETFs
  

  Have you ever wanted to short the market because you knew it was going down but your were too overwhelmed, nervous or even scared because you were unsure of how to do it. Well, Inverse ETFs may be your thing.

  These inverse ETF’s closed Wednesday with gains of 13.42%, 15.43%, 22.31% and 18.76% since I wrote about them.

• 10/18/07:The Real PTR Climax Run?
  

  I was early in September by trying to locate a climax run in PTR in this post:
  Petrochina (PTR) Climax Top? However, the HUGE volume on the latest push to new highs clearly indicates something is going on.

• 10/20/07: Second Major Distribution Day
  

  Technically speaking, we now have 4 distribution days for the NASDAQ and 3 for the DOW over the past month. It’s now time to start focusing big-time on the market leaders to see where they are going to take this market. If they start to roll over, you better be quick to take profits and even quicker to take losses.

• 11/01/07: CROX getting Swallowed
  

  I wrote a post titled Will CROX get Eaten? on September 20, 2007 and strongly noted the declining institutional support (see numbers below). Someone was jumping out of the stock and we now know why!

• 11/08/07: Market Corrections, Bears and the Big Picture
  

  Keep in mind that nearly 75% of all stocks follow the general market trend. Your cash doesn’t need to be committed to the market at all times. This philosophy is suited to making the most money in bull markets or markets trending higher.

• 12/11/07: When to Sell
  

  Why do so few books exist on the subject of “How to Sell”? Selling techniques are far more complicated than buying techniques and subject to considerably more emotional pressure, than those of buying.