The following is meant for educational purposes only and is by no means investment advice. Before investing in stocks, ETF’s, bonds, or any other investment vehicle, please seek the advice of an investment professional.
The data and charts used for this post come from Friday January 11th, 2013:
Let’s say you just happened on this site, you see the various pages that outline my system, but you’re not really sure how it all fits together. Basically there are two parts of the system, stock charts and breadth indicators. Looking at charts is one thing but when you include breadth indicators in your daily study of the market, then you get a much better and deeper understanding of the market as a whole.
In order to know whether or not my system will work for you, it would be best to paper trade it for a while. In the current market environment, the second week of January, 2013, there wouldn’t be much to do as there have been neither any new ‘buy’ signals nor ‘sell’ signals lately, but this is bound to change. In the next few days or weeks, the market will reach some extreme level of overboughtness or oversoldness per breadth indicators and when either of these situations presents themselves then at that time you can test the system with a paper trade or two. IMHO, the system is best utilized for trading and not for buy-n-hold investing and it is intended for use with major ETF’s such as QQQ, SPY, DIA, IWM, XLF, etc.
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The stock market can only go in one of three ways: up, down, or sideways so the first thing that you have to determine is market direction. Is the market consolidating sideways, is the market putting in a series of higher highs and higher lows, or is the market putting in a series of lower lows and lower highs?
In the daily $SPX chart below, you can clearly see that this key index has put in several higher highs and higher lows which means that an up trend is in place. I’ve put a trend line on the chart and this confirms that the trend is up. Even after the $SPX’s excursion below the trend line due to doubts about the fiscal cliff bs, $SPX managed to rise and get back above the trend line. For further confirmation, you might want to look at a chart that includes some moving averages to make sure that the MA’s are rising and that the shorter term MA’s are above the longer term MA’s. As long as this is the case, then the up trend is further validated.
See also the “5/10 & 9/20 Daily Chart Methods.”
For a bit more confirmation, you might want to look at a 60 minute chart to make sure that the important MA’s are where they should be.
On this 60min SPY chart, everything looks good. Even if SPY should pull back some, it would take a serious pull back to turn the 200EMA.
Chart courtesy of TradingView.com
For more on 60 minute charts, see the “60 Minute Trading Strategy” page.
At this point, then, you’ve determined that the market is in a rising trend but you’ll want to know how the market looks under the hood: is it moving with strength or are breadth indicators warning that the market is getting overbought and setting up for a pull back of one degree or another? To do this, you’ll want to look at breadth indicators and you’ll want to know if the breadth indicators are giving neutral readings or are they giving extreme overbought readings so let’s take a look at a few key breadth indicators and their readings from Friday January 11th, 2013.
Zwieg Breadth Thrust: 57.00
This reading is getting a little high but it has not reached the important 60 level so this is considered a neutral reading.
$NYSI: + 40.48 pts on the day and 736 for the index overall.
This is a good reading showing that the market is moving with strength.
Cumulative Volume Index: -811
Hmm. Now that is a red flag. This is based on the cumulative volume of the $NYA & the $NYA did close down 1.36pts so this isn’t truly a non-confirmation. Still, a reading such as this would need to be highlighted.
This is a good and strong reading and it means that by point & figure charting 77.20% of stocks in the $SPX are currently ‘buys.’ But this is also showing that the market is getting overbought. Some would say that adding to existing positions or entering new positions when $BPSPX gets above 75 is asking for trouble. At this point you would want to look back with an eye for what happens in the market when $BPSPX reaches levels such at 77.20.
Again, this is a good and strong reading but, like $BPSPX, it is showing that the market is getting overbought and you would want to look back to see what kind of market reaction could be expected once you get readings in this range.
For more on breadth indicators, check the “Breadth Indicators” page.
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And that is how you would put the pieces together. We know that on January 11th, 2013 the market is in a rising trend and we know that it is moving with strength. We also know that it is reaching overbought levels but that the market probably has more head room before one really needs to get worried.
The market is dynamic and repeats patterns over and over again. If you are watching a trend line and tracking breadth indicators, then, most of the time, moves in the market won’t surprise you and catch you off guard. But just beware that it’s never so simple and so you must always remain vigilant.