Wednesday, November 14, 2007

Gauging the Extent of Market Moves and an Indicator Update

It was quite a nice rally, but the indicators were tracking strength even as we were declining in the two prior days, as the recent post noted. Whenever I see persistent selling pressure (weak NYSE TICK) in a market that's not weakening or persistent buying pressure (strong TICK) in a market that's displaying fewer new highs, lower momentum, etc., I generally look for those late to the move to get wiped out on the reversal. That's pretty much what happened on Tuesday. All those late to the selling had to cover their shorts and the rally fed on itself during the day, with very strong TICK readings.

One mechanism I've found helpful for gauging the extent of market moves after a reversal is to count the net number of contracts transacted at the bid vs. offer and then assume that at least that many will need to be covered before the reversal is complete. Market Delta is helpful for those calculations. So instead of a price target, you have a target based on volume. If a net 150,000 contracts were transacted at the bid during the market weakness while the indicators were strengthening, the reversal will last for at least 150,000 contracts transacted at the offer. Having a heuristic like that can help you stay in a trending move.

We finished Tuesday with 174 new 20-day highs and 638 new lows. What we'd want to see from the bulls here is an ability to continue to reduce those new lows. One day doesn't make a bull market; it's the follow through that counts. If we digest these gains and then see another rally on top of this past one, that would be the pattern we'd look for to signal a more durable market bottoming taking place. If this market is going to tank, I suspect it will be because of either a meltdown in China or a meltdown in our own financial sector. So I'll be watching those segments carefully. As I mentioned in my Trading Psychology Weblog, an outright bear market is not my primary scenario, but I'm open to the possibility as an alternative.

My Demand indicator was 117; Supply was 20. That means that we had more than 5 times as many stocks close with significant upside short-term momentum as downside momentum. When we see momentum jump like that, usually there's some price follow through to the upside over the next few days.

The number of S&P 500 stocks trading above their 50-day moving averages jumped to 37% on Tuesday. That same percentage holds for S&P 600 small caps, which of late have resisted selling. In a bottoming process we see rising bottoms in this indicator, so I'll be looking to see how we fare on any pullbacks.

Among NYSE common stocks, we had 22 annual new highs and 37 new lows--a significant contraction of new lows. Again, we want to see if that continues.

In short, we had a significant rally no doubt fueled by short covering following a couple of days in which lower prices in the major indexes were not confirmed by indicator weakness. Now we're seeing significant upside momentum. I will need to see weakness in the indicators before trading from the short side as a primary strategy.


The Structure of Stock Market Reversals