Imagine that the S&P 500
Index ($SPX) has just zoomed to a daily high, inching above levels reached
earlier in the day. You take a look at the
market leaders for the day and you find that one S&P 500 component has risen
three full points on positive news in the last few minutes. No other
stocks have made new highs for the day.
Is this a strong market or a weak one?
This example, while admittedly uncommon, points out the limitations of
relying solely upon price and volume when gauging market movements. Both
price and volume can rise sharply when a few components of a cap-weighted index
move dramatically. A fairly common example would be energy stocks moving
strongly on oil prices, without corresponding movement among consumer,
industrial, technology, and financial stocks. When a relative few issues
are heavily weighted in an index, such as the S&P 500 and the Dow Jones
Industrials, price and volume for the averages can be misleading. A market
can rise ten points with broad participation or with very narrow involvement.
It is unwieldy to track all 500 stocks in an index, so I typically rely upon
a smaller basket of stocks to represent the market average. I utilize
several such baskets in my trading; all of them draw equally from consumer,
cyclical, financial, and technology sectors to capture an accurate market
cross-section. I also tweak the baskets periodically to ensure that they
are highly correlated with the index I am trading. My
recent research finds that short-term new highs and lows among the stocks in
a representative basket nicely anticipate the odds of a bull move continuing in
its current direction vs. reversing.
Below is a chart of new two-hour highs minus lows tracked on a closing
five-minute basis with a basket of 17 large cap issues that are highly weighted
(but broadly distributed by sector) within the S&P 500 Index.
Note the market's tendency to reverse rises when price highs in
the index (SPY) are not accompanied by an expansion of new highs (downward
arrows). A similar pattern occurs at many important market bottoms and may
be setting up in late Friday trade.
A different way to track participation is simply to follow
charts of actively traded sector ETFs and see how many are confirming moves in
the broad market average. Very often, individual sectors, such as
semiconductors or financial issues, will fail to confirm new price highs and
lead you to question the vigor of the move. I also like to treat the
Russell 2000 stocks (IWM) and NASDAQ 100 issues (QQQQ) as sectors and see if
they're confirming moves in the large caps.
It's not enough to notice a rising tide; you also want to see if
it's truly lifting all boats. How a market moves is just as important
as how much it moves.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
His book, Enhancing
Trader Performance, is due for publication this fall (Wiley).
