Saturday, December 06, 2008

Advance-Decline Line Strength and a Look at Technical Strength


A nod to Decision Point, which tracks the advance-decline lines specific to various sectors and indexes. What we see is that, despite very bad economic news--including Friday's dismal jobs report--the advance-decline line for S&P 500 stocks (bottom panel, above) continues to grind higher. A similar pattern can be seen for the advance-decline line that extends to all NYSE common stocks. Indeed, we've seen advancing issues outnumber decliners in eight of the last ten trading sessions.

The 900 level in the S&P 500 Index looks like the important resistance to tackle in coming sessions. We've seen recent important support in the low 800 area, as the market has traded in a volatile, choppy fashion that has delighted daytraders and frustrated longer-term trend followers. I'm finding that my Technical Strength measure, which quantifies the degree to which a stock is trending up or down over a short time frame, is useful in identifying these range bound markets.

We can think of Technical Strength as a kind of goodness-of-fit measure to a regression line. A stock that shows little variation around an upward or downward regression line can be said to be highly trending. A stock that shows high variation relative to its degree of slope can be said to be non-trending. In constructing the Technical Strength measure, I artificially assign a score of +100 to a near-perfect uptrend and -100 to a near-perfect downtrend. A score near zero denotes a non-trending stock.

I calculate Technical Strength scores for each of forty stocks in my basket: five highly weighted issues across the Industrial, Materials, Energy, Consumer Discretionary, Consumer Staples, Financial, Health Care, and Technology sectors within the S&P 500 Index. These forty stocks give me a good snapshot of the large cap stock universe.

What I've found to be helpful is categorizing each stock as either neutral, weakly up/down trending, or strongly up/down trending based upon its Technical Strength score. During my recent sector review, I found that only a mere handful of stocks in the basket were either strongly uptrending or downtrending. Every other stock was either neutral or weakly up/down trending. When I cumulated the scores for the five stocks in each sector, *no* sector was strongly trending up or down. That was a great tell that we were not in a trending market, which means that fading moves to range extremes--not playing for breakouts--was the most successful short-term trading strategy. Friday was a great example of that.

I've found that the morning Twitter posts are an effective way of blasting indicator information to interested readers. The subscription is free, and the "tweets" also include links to articles and blog posts that pertain to market-moving themes. I will be adding regular Twitter updates regarding Technical Strength to the indicators I regularly follow before each trading day. That should help traders identify trend/non-trend markets, but also catch the shifts from one environment to the other.
.