General Market Indicators

Jun 17, 2020
13 min read

Updated: Jul 3, 2020

Analyse an entire market.

Disclaimer: content is summarised from Part 6 (Chapter 34 - 37) of 'The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management' by Alexander Elder

1. The New High–New Low Index

Leader in strength: stocks that reach their highest level for that year on any given day. Leader in weakness: stocks that fall to their lowest level for that year on same day.

NH-NL tracks behaviour of market leaders. Elder says NH-NL is the best leading indicator of the stock market.

Constructing NH-NL

Data is loosely reported as some only track NYSE stocks while others are too broad, tracking even i/r ETFs. Using www.barchart.com to extract data, calculate NH-NL & plot the result underneath daily chart of S&P 500 would be the approach to take.

Make 2 lists for stocks in your country that have reached highest high & lowest low for the year during the day. Apply numbers found to the formula for NH-NL.

NH-NL is positive when NH > NL, vice versa. NH-NL Index is plotted as a line, with a horizontal reference line at a zero level.

While plotting NH-NL below S&P 500, note that it has a much broader reach than S&P as NH-NL includes data from NYSE, AMEX, & NASDAQ. It excludes only ETFs, unit investment trusts, closed-end funds, warrant stocks, & preferred securities. Chart of S&P 500 is there just for a comparison.

Crowd Psychology

A stock reaching yearly high suggests that eager bulls are chasing its shares. A stock reaching yearly low suggests that aggressive bears are selling its shares.

NH-NL Index reveals balance of power between leaders of strength & leaders of weakness.

Broad indexes, like S&P 500 tends to follow trend of NH-NL.

When NH-NL turns positive, bullish leadership is dominant. When NH-NL turns negative, bearish leadership is dominant.

Uptrend is likely to continue if market rallies to a new high & NH-NL reaches a new peak. Uptrend is in danger if market rallies but NH-NL shrinks, showing weakened bullish leadership.

Downtrend is likely to continue if market falls to a new low & NH-NL reaches a new bottom. Downtrend is in danger if market falls but NH-NL turns up, showing weakened bearish leadership.

Trading Rules for NH-NL

1. NH-NL Zero Line

When NH-NL is positive, bullish leadership is stronger hence, long. When NH-NL is negative, bearish leadership is stronger hence, short. NH-NL can stay positive for months in bull markets & negative for months in bear markets.

Uptrend is likely if NH-NL is negative for several months then rallies above its center-line. Find buying opportunities using oscillators for precise timing. Downtrend is likely if NH-NL stays positive for several months then falls below its center-line.

2. NH-NL Trends

Uptrend confirmed when market & NH-NL rises. Downtrend confirmed when market & NH-NL declines.

Take profits from longing uptrends if NH-NL declines while broad market stays flat / rallies. Cover shorts from shorting downtrends if NH-NL rises while market falls.

Rising NH-NL on a flat day gives a buy signal. Falling NH-NL on a flat day gives a signal to sell short.

3. NH-NL Divergences

Divergence between patterns of NH-NL & market indexes shows that reversals are likely.

1. Bearish divergence occurs when NH-NL traces a lower peak & market rallies to a new high. It shows weakening bullish leadership & often marks end of uptrends. If height of 2nd peak is in the low hundreds (barely positive), a big reversal is likely hence, go short. If latest peak is in the high hundreds, upside leadership is strong enough to prevent a market collapse.

2. Bullish divergence occurs when market declines to a new low, but NH-NL traces a shallower bottom than its previous decline. If latest low of NH-NL is in the low hundreds, bearish leadership is exhausted & major upside reversal is near. If latest low sinks deep, downtrend may pause but not reverse.

Note that bullish divergences at stock market bottoms tend to develop faster than bearish divergences at market tops: buy fast & sell slowly.

S&P 500 daily, 26- & 13-day EMAs, Autoenvelope, NH-NL daily. (Chart by TradeStation)

Chart tracks daily NH-NL during a mostly bullish year for stocks. Every bullish trend gets interrupted by pullbacks. Bearish deterioration patterns of NH-NL, at diagonal red arrows, warns of coming declines.

Declines end & rallies begin when NH-NL rallies from negative to positive at purple circles. Those signals work especially well when the S&P is oversold e.g. near its lower channel line. Trading messages are especially strong when independent signals confirm each other.

NH-NL in Multiple Timeframes & Look-Back Periods

Markets move simultaneously in different timeframes.

Weekly NH-NL

Confirms major market trends & identifies major reversals. Built from daily data of barchart.com by running a 5-day moving total. Result is plotted underneath a weekly chart of S&P 500.

Gives most important signals when it reaches extreme levels & by divergences. E.g. weekly NH-NL rises to +1,500 means that there was an average of 300 more NH than NL for the past 5 trading days. To push weekly NH-NL to an extreme would take a period of sustainable bullishness / bearishness.

Most important signals of weekly NH-NL:

1. Drops below - 4,000 then rallies above that level: major buy signals

2. Rises above +2,500: confirms bull markets

3. Tops / bottoms of weekly NH-NL diverges from price: major reversals

Drop below −4,000 reflects an unsustainable market panic which is not going to last. Market delivers average of 800 more daily NL than NH for 5 days in a row. This signal, Elder claims, has only misfired once in decades and is effective in bull & bear markets. (Elder calls this buy signal a "Spike")

Rises above +2,500, never occurs during bear market rallies. Hence once seen, you know you're in a bull market, with higher prices likely ahead.

S&P 500 weekly, 26-week EMA, NH-NL weekly. Green line at +2,500, purple line at −4,000. (Chart by TradeStation)

When weekly NH-NL falls below −4,000 & then rises above that level, it nails important bottoms, at green arrows. Chart covers 11 years & the signal works except in Oct & Nov 2008, at purple oval. Remember that no market signal works 100% of the time.

Red arrows mark major bearish divergences.

When Weekly NH-NL touches +2,500, it confirms bull markets & calls for higher prices ahead, even if interrupted by a correction.

65-day & 20-day NH-NL

Daily NH-NL compares each day’s high & low to the high-low range for the preceding year. 20-day NH-NL compares it to the preceding month & 65-day NH-NL to the preceding quarter. These are useful for short-term timing.

Before reaching a new yearly high, a stock must first make a new monthly high, then a quarterly high. With a downtrend, it may take a long time to recover & reach a new yearly high, but it can reach monthly & quarterly highs sooner.

When 20-day NH-NL drops below -500 & then rallies above that level, market has touched & rejected a shortterm bearish extreme, & usually then launches a short-term rally. This a “Spike bounce” signal.

Tracking market leaders with NH-NL helps improve timing. 2 ways to use NH-NL signals: 1. since individual stocks largely depend on broad market trends, NH-NL signals can decide when we buy / sell. 2. Use NH-NL signals to trade vehicles that track the broad market like S&P e-mini futures.

2. Stocks above 50-Day MA

Based on key concepts regarding prices & MA. Each price represents a momentary consensus of value among market participants. MA represents an average consensus of value during its time window. When a stock trades above its MA, consensus of value is above average, bullish. When a stock trades below its MA, consensus of value is below average, bearish. In an uptrend, % of stocks above their MA grows. In a downtrend, % of stocks above their MA shrinks.

This indicator tracks all stocks traded on NYSE, American Exchange, & NASDAQ. It calculates how many of them trade above their MA. It plots that % (from 0 to 100) as a line.

Viewing it on a weekly chart helps to catch intermediate reversals where market turns lead to trends that last from weeks to months.

Only exceptional market moves swing near 90% / 10% extremes. Normally, this indicator tops out near 75% & bottoms out near 25%. Hence, Elder draws 2 reference lines, 75% & 25% on the chart.

% of stocks above 50-day MA gives trading signals not by reaching certain levels but by reversing near those levels. It signals completion of a top by rising to / above the upper reference line & then sinking below that line. It signals completion of a bottom by falling below / near the lower reference line & then turning up.

Notice that tops of this indicator tend to be broad, while its bottoms are sharper. Tops are formed by greed; a happier, longer-lasting emotion. Bottoms are formed by fear; a more intense, shorter-lived emotion.

Some of this indicator’s signals are on time in catching reversals, while others mark only temporary pauses in major trends.

S&P 500 weekly & 26-week MA; Stocks above 50 MA with reference lines at 75% & 25% (Chart by TradeStation)

As this indicator reaches extremes of above 75% / below 25% & then moves away from that level, it shows that intermediate-term trend has likely reached a turning point. Reversal of this indicator flashes a signal for the entire market: buy when it turns up & sell when it turns down. In the 2nd half of 2013, as the market goes up with few pullbacks, buy signals from upside reversals occur at levels higher than 25%. These signals don’t mark every reversal—no indicator does—but when it flashes its signal, pay attention.

3. Advance / Decline

Ad/D line tracks degree of mass participation in rallies & declines. Everyday, it adds up no. of stocks that closed higher & subtracts no. of stocks that closed lower. NH-NL focuses on leaders while Ad/D line shows if leaders are being followed. Turns of this indicator usually coincides with price turns, but occasionally precedes them hence Ad/D line has the ability to give early warnings.

E.g. out of 4,000 stocks, 2,600 advanced, 900 declined & 500 unchanged, hence Ad/D = +1,700 (2,600−900). Each day's Ad/D is added to previous day to create a cumulative Ad/D line.

If Ad/D line rises to new high, rally is likely to persist. If Ad/D line falls to new low, decline is likely to persist.

Watch for new peaks & valleys rather than absolute levels. Rally has broad support & is likely to continue with new high in market & Ad/D line. Broadly based rallies & declines have greater staying power. Fewer stocks are participating in rally & trend may end soon if market reaches a new peak, but Ad/D line reaches a lower peak than during the previous rally. Fewer stocks are participating in decline & trend may end soon if market falls to a new low but Ad/D line traces a shallower bottom than during the previous decline. These signals tend to precede reversals by weeks if not months.

Old Indicators

Changes in the market have killed many indicators. Volume indicators of low-priced stocks died when average volume of U.S. stock market soared & Dow rose tenfold. Member Short Sale Ratio & Specialist Short Sale Ratio died as options became popular. Member & specialist short sales are now tied up in the inter-market arbitrage. Odd-lot stats died when conservative odd-lotters bought mutual funds. Odd-lot Short Sale Ratio died when gamblers discovered puts.

S&P 500 daily & the Advance/Decline line. (Chart by Stockcharts.com)

At (A), prices stratch the bottom & make a new low, while uptrend of Ad/D line calls for a rally. At (B), the opposite occurs—prices press higher, while a downturn of Ad/D line calls for a decline. At (C), prices continue to decline, while A/D line turns up & calls for a rally. Those warnings do not occur at every turning point.

4. Consensus & Commitment Indicators

Most private traders are not vocal, unlike financial journalists & bloggers. The financial press in general has a poor record of market timing as they tend to overstay trends & miss turning points. Thus, when these groups become intensely bullish / bearish, it pays to trade against them. When financial journalists reach a high degree of bullish / bearish consensus, it’s a sign that the trend has been going on for so long that a reversal is near.

Consensus indicators, aka contrary opinion indicators, are unsuitable for precision timing but shows that a trend is near its end. After the signal, switch to technical indicators for more precise timing of a trend reversal. A high degree of consensus precedes reversals. When the crowd gets highly bullish, prepare to sell. When it gets strongly bearish, prepare to buy. The majority is wrong at market turning points: prices are established by crowds & by the time the majority turns bullish, insufficient new buyers fails to support a bull market.

Tracking Advisory Opinion

Letter writers follow trends in fear of losing subscribers by missing major moves. Moreover, bullishness is favoured by subscribers. Letter writers get more vocal of trends, the longer it continues. They are most bullish at market tops & most bearish at market bottoms. An explosion of interest in behavioural economics has occured in recent years, & today many services track letter writers / advisors. Elder claims SentimenTrader.com does a good job of tracking mass market sentiment.

Signals from the Press

Financial journalists want to appear serious, & informed & are afraid of appearing ignorant / flaky. Hence they straddle the fence & present several sides of every issue. They will only pick sides for powerful & lasting trends which occur when a tide of optimism / pessimism sweeps up the market near the end of a major trend, which is when it is ripe for a reversal. Front covers of major business magazines serve as contrarian indicators. When a leading business magazine puts a bull on its cover, it is usually a good time to take profits on longs.

Signals from Advertisers

3 or more ads touting the same “opportunity” warns of an imminent top. By the time a trend is found, trading recommendations are formed, ads are produced, & placed in a newspaper / magazine, trend is very old.

Monthly total dollar value of OTC stocks. (Courtesy SentimenTrader.com)

Money pours into penny stocks when the market is up, dries up when it is down. This is reflected in the monthly reports of penny stock volume at the NASDAQ. After markets have hit new highs and the news is good, volume often spikes up for these “lottery ticket” stocks. When the stock market hits the skids, their volume dries up.

Commitments of Futures Traders

Government agencies & exchanges collect data on trading by various groups of traders & publish summary reports of their positions. Trade with groups that have a track record of success & against those with persistent failure.

Commodity Futures Trading Commission (CFTC) reports long & short positions of hedgers & big speculators. Hedgers, commercial producers & consumers of commodities, are the most successful market participants. Securities and Exchange Commission (SEC) reports trading by corporate insiders. Officers of publicly traded companies know when to buy / sell shares. Positions of large futures traders, including hedge funds, are reported to the CFTC when their sizes reach "reporting levels". If you are long / short 250 contracts of corn / 200 contracts of gold, CFTC classifies you as a big speculator. Brokers report those positions to the CFTC, which compiles the data & releases summaries on Fridays. CFTC also sets up max no. of contracts a speculator is allowed to hold in any given market (position limits). Limits prevent very large speculators from accumulating positions big enough to bully markets.

CFTC divides all market participants into 3 groups: commercials, large speculators, & small speculators. Commercials, aka hedgers, are firms / individuals dealing in actual commodities in the normal course of their business. In theory, they trade futures to hedge business risks. E.g. bank trades interest rate futures to hedge its loan portfolio, while a food processing company trades wheat futures to offset the risks of buying grain. Hedgers post smaller margins & are exempt from speculative position limits. Large speculators are those whose positions have reached reporting levels. CFTC reports buying & selling by commercials & large speculators. To find positions of small traders, take open interest & subtract holdings of the first 2 groups. Divisions between hedgers, big speculators, & small speculators are somewhat artificial. Smart small traders grow into big traders, dumb big traders become small traders, & many hedgers speculate.

Some market participants play games that distort CFTC reports. E.g. owner of a brokerage firm may register his wealthy speculator clients as hedgers, claiming they trade stock index & bond futures to hedge their stock & bond portfolios. Commercials can legally speculate in the futures markets using inside info. Some of them are big enough to play futures markets against cash markets. E.g. an oil firm may buy crude oil futures, divert several tankers, & hold them offshore to tighten supplies & push up futures prices. They then take profits on longs, go short, & then deliver several tankers at once to refiners to push crude futures down a bit & cover shorts. Such manipulation is illegal, & most firms hotly deny that it takes place. As a group, commercials have the best track record in the futures markets. They have inside info & are well-capitalised hence, follow them in the long run. Big speculators used to be successful wealthy individuals who took careful risks but today most big traders are commodity funds. These trend-following behemoths do poorly as a group. The masses of small traders are the proverbial “wrong-way Corrigans” of the markets. It is not enough to know whether a certain group is short / long. Commercials often short futures as many of them own physical commodities. Small traders are usually long, reflecting their perennial optimism. To draw valid conclusions from the CFTC reports, you need to compare current positions to their historical norms.

Legal Insider Trading

Officers & investors who hold >5% of shares in a publicly traded company must report their buying & selling to SEC. SEC tabulates insider purchases & sales, then releases this data to the public. Corporate insiders have a long record of buying stocks when they’re cheap & selling them high. Insider buying emerges after severe market drops, & insider selling accelerates when market rallies & is overpriced. Analysts who researched legal insider trading found that insider buying / selling was meaningful only if more than 3 execs / large stockholders bought / sold within a month (rise if they bought, fall if they sold). Clusters of insider buying tends to have a better predictive value than clusters of selling as insiders are willing to sell a stock for many reasons (diversification, buying a second home, sending a kid to college) but they are willing to buy for one main reason—they expect their company’s stock to go up.

Short Interest

Few traders, including professional fund managers sell stocks short. Exchanges also report no. of shares held short for any stock. Compare the no. of shares held short to float (total no. of publicly owned shares available for trading). This number, “Short Percent of Float,” tends to be around 1% or 2%.

Alternatively, look at short interest by comparing it to average daily volume. Doing so begs a hypothetical question: if all shorts cover, while all other buyers stood aside & daily volume is unchanged, how many days would it take for them to cover & bring short interest down to 0? This “Days to Cover” number tends to be 1 or 2 days.

Check Short % of Float & Days to Cover when planning to buy / short a stock. If they are high, bearish side is overcrowded. A rally may scare those bears into covering, & send the stock sharply higher. Bulls may look for bargains but try not to overpay, while squeezed bears, facing unlimited losses, will pay any price to cover. Hence, short-covering rallies tend to be especially sharp.

When buying, note that normal readings do not provide any great info, but deviations from the norm often deliver useful insights. High shorting numbers mark any stock as a dangerous short. E.g. your indicators suggest buying a stock & high short interest provides another buy signal. It makes sense for swing traders to include data on shorting when selecting stocks to buy / sell short.

AAPL & GMCR shorting data. (Source: Shortsqueeze.com)

Short Percent of Float is 1.86% for AAPL & nearly 26% for GMCR. Days to Cover is 0.9 for AAPL but over 15 for GMCR. These reflect much more aggressive shorting of GMCR. Note that, all of those shorts at some point will need to buy in order to cover. Perhaps savvy shorts know something very bad about GMCR, but what if its stock rallies even a little? Many bears will run for cover, and as they scramble to cover shorts, the stock may soar. Whatever its long-term prospects, it could be sent flying in the near term.