There are a few indicators I follow daily that reflect momentum and strength in the stock market. I look to these indicators to give me an idea of whether stocks overall are strengthening or weakening. If strengthening, I tend to look for continuation of uptrends or short-term reversals of downtrends. If weakening, I look for downtrends to continue or uptrends to reverse. I use these measures more as a heads-up than as precise timing devices. They've been very helpful in keeping me in trending moves and avoiding chasing moves that are about to reverse.
So what are the indicators and what are they saying now?
My first measure is the number of stocks in the S&P 500 Index that are trading above their 50-day moving averages. At present, that percentage is 23%, which has--over the last few years--been a level at which we've tended to see intermediate-term market bottoming. What that tells me is that, if we're in a corrective mode, we should start to see some signs of market bounce shortly. If we fail to see buying after a dip such as we've had, that would be more consistent with a bear market scenario. Among S&P 600 small cap issues, we similarly see 23% above their 50 day MA. This, too, is consistent with levels we've seen at recent intermediate-term lows.
A second measure I like to look at is the number of NYSE common stocks (not all NYSE issues) that are making fresh 52-week lows. This is my favorite measure of the health of the broad market. Here we see that, on Monday, we registered 7 new annual highs against 94 lows. Interestingly, this is the second consecutive day in which the market has closed lower, but with fewer stocks making new lows. This is very much worth watching. It says to me that the downside might be drying up here; in the past, it has paid to look for signs of near-term reversal.
A third measure I track is the advance-decline line specific to those NYSE common issues. This is a second useful way of tracking the health of the broad market. Here we see that the AD line is pretty much where we were at the August lows. I am watching carefully to see if we break those lows. Meanwhile, the AD line specific to the S&P 500 Index stocks remains above its August lows, as is the case for the NASDAQ 100 Index. The AD line specific to the Dow 30 Industrials is unusually strong, suggesting that money may be flowing to these large caps during the market weakness as a kind of flight to quality. The AD line specific to the S&P 600 small caps has been making new lows during this downturn, though it has also stabilized over the last two trading sessions--something I'm again watching.
A particularly sensitive indicator of market strength and weakness is the number of stocks across all the major exchanges that are making fresh 20-day new highs vs. new lows. Here we see on Monday that we had 131 new 20-day highs against 1137 new lows. Once again, we're seeing new lows dry up, even as the market has moved lower of late.
Finally, my favorite momentum measure reflects the number of stocks that are closing above and below the volatility envelopes surrounding their short-term moving averages. I translate these figures into an index that I call Demand and Supply, respectively. On Monday, Demand was 58 and Supply was 67. That is a narrower gap that one would normally expect after market weakness, with Supply running below levels from the past week. That tells me that fewer stocks are maintaining downside momentum.
So what does all this mean? It tells me that, for now, the market is weak, but it is not weakening. Indeed, most measures of strength and momentum are making higher lows even as we close lower. That puts me on watch for possible short-covering rallies and serves as a heads-up for possible intermediate-term bottoming. I don't discount the possibility of further bear action, but need to see it reflected in my indicators before I sell market lows.
Principles of Short-Term Trading