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Because these are not averages most investors watchGARTLEY ON VOLUME H.M. Gartley was a great technician in the 1930s. He did more work on volume than any other man. In 1933, he wrote: Note that bear market cycles begin on reduced volume. As the major (downward) phase develops, volume increases and this phase ends in a selling climax on heavy volume. The ensuing rally (corrective phase) is accompanied by declining volume, which dwindles until the rally loses momentum completely, and the major trend is resumed in a new bear cycle. . . . Bear market rallies start out of active selling climaxes. Note that the first six bear market rallies, following the 1929 top, came out of heavy trading. But the rally in July 1932 came out of extreme dullness, indicative of a major reversal (a new bull market began on July 8, 1932). The rationale behind the diminishing volume in bear markets is simply that the public loses interest as it loses money. Also, they have less capital to trade with, owing to those losses. 7. DJIA 30-week moving average. Add the last 30 Friday closing prices of the Dow Jones Industrials (as with any average) and divide by 30. Then, each week, add the new DJIA figure and subtract the 31st week back. Chart it alongside the DJIA. Alternatively, this can be done via computer chart services automatically. But doing it manually, or at least knowing how, gives you a feel for the process. Generally, the 30week moving average (of a stock or an average) stays above the current price in bear markets, below it in bull markets. It gives cues and clues when the price attempts to penetrate the moving average. If penetration lasts for several weeks, it can usually be regarded as a valid signal. Some prefer a 40-week moving average. It is probably best to keep both if you have the time. Also, a 10-week moving average is believed to be highly sensitive and useful for short-term trading. You can create your own moving average as an experiment. . Overbought-oversold index. There are many forms for this index and the best one has yet to be invented. Quite popular is the 10-day moving average of the difference between advances and declines. When a rally moves up too fast, the advances pile up and an overbought condition is created, which usually is soon corrected. The same in reverse, with declines. About 1,200 is considered overbought land, and 1,600 is the start of oversold territory. When this (or any other) indicator goes wrong, however, it can cause you heavy losses if you rely too heavily on just this one. You always tell yourself: Im too smart to ever rely on any one index, but when the time comes and you see an extreme reading on some usually reliable indicator, you often get carried away in the desire to get a jump on the crowd with this apparent solid backing. I have a personal method of interpreting the overbought-oversold 10-day index, which is even more useful than the traditional approach just outlined. If you chart this back for some months, you will see how you can apply normal stock chart analysis and get better results. Youll find rare wedges appear, and longer-term (multi-month) trend lines are fabulously successful as cues when broken up or downside. As this is a smoothed-out (10-day) version of what the market is really doing (advances-declines), its logical that critical information is hidden here awaiting your discovery. Also, note that some stocks/commodities are more responsive to this (or any tool) than others. If you track their history, youll find such varying sensitivity of great help. 9. Confidence index. No market book is complete without a comment on Barrons Confidence Index. This figure represents the ratio between the yield on high-risk and low-risk bonds and supposedly shows the thinking of the elite money minds. The record of the CI has been distorted by many to force its record into proving it is always right. I have made a 5-week and a 10-week moving average of it and also charted it raw over many years and cannot escape the conclusion that when it works, it works; and when it doesnt, it doesnt. Its batting average some years is 100%. In other years: zero. Its just one tool in your tool kit. 10. Short interest. This is published between the 15th and the 20th of each month. The amount of shares sold short has a relationship to the future since those shares must be bought back someday. This must be used in conjunction with the Short Interest Ratio. Arbitrage disfigures short interest. Arbitrage is an aspect of short interest that again points out the danger of blindly reading a big short interest as bullish, or a small one as bearish. Often, a stock will be shorted as a means of taking a small profit in a special situation via an arbitrage action. And, in the last several years, online advisory services have sprung up where arbitrage is a major investment strategy. Several circumstances can cause arbitrage trading, and it does not mean people are actually shorting because they are bearish. It is a process where traders buy and sell the same stock, often holding both long and short until the proper time. This can come about, for example, in a planned takeover of one company by another. Arbitrage is a term applied to transactions where a trader may buy the convertible bonds of a company and sell the stock into which the bonds may be converted. The bonds, after conversion, furnish cover for the sale of the stock. Arbitrage is also used to take advantage of the different pricing for the same item between, say, New York and London, or Frankfurt and Hong Kong. I am discussing arbitrage here primarily as a distorter of short interest. So, bear in mind that it can, at times, easily amount to 5-10% or more of the markets short total. In many instances, the total short interest monthly direction is contrary to truth if you subtract the arbitrage shorts. 11. The Short Interest Ratio. This measures the market volume against the shorts, once a month. Short interest is simply divided by current average daily volume. When the ratio is large (2% or higher), its bullish, for it means there are too many shorts for the amount of volume going on. When its small (1% and below), its bearish. There are refinements you can make. Maybe a 5-day moving average of volume could be computed and a new ratio calculated weekly from that. 12. Brokers Free Credit Balance Index. The amount of money (credit) held in customers accounts is latent buying power. Measuring this amount monthly is of more than passing interest. It tells us, rather reliably, what stage of a bull or bear market we are in. Customers tend to use up more of this credit cash as a bull market is reaching its top. They tend to let more of this money stand idle during the first half of a bull run because they arent convinced yet. These figures are found in Barrons, as are most statistics you need for most indexes. Barrons and a quality daily newspaper with good financial coverage, and an online statistical service are musts for keeping up your indicators. And though, these days, it is possible to obtain many of the indicators, mentioned here, ready made over the Internet, until you are familiar with them, I strongly advise you to physically plot them yourself to get a feel for each oneand the market. Just as the best way to learn new computer software is to use it, and merely being told how it works doesnt give you an understanding of how it handles, so it is with market indicators. Plot them by hand until you reach a point where they become part of your inner pre-verbal wisdom and judgment. Once you reach a point when you can sense what the latest numbers mean for the overall market picture, even before you have entered them on your charts, then are you ready to have somebody else (a computer program or service) do the plotting for you. 13. Debit Balances Index. This is the mirror image of the above index. Information here represents the money owed to brokers in margin accounts; thus, it is the reverse of the Credit Balance Index. This index represents shrewder traders. Thus, this total tends to rise during the first two stages of bull markets. It generally tops out in the last portion of a bull market and drops steadily through the bear market following. 14. Nasdaq indexes. The Nasdaq reflects the more speculative aspects of Wall Street, and no bull market can long exist unless or until the speculative element is active. Blue chips alone never made a bull market. You should make an advance-decline line for the Nasdaq the same way as you do for the DJIA. Also, a highs-lows index can be made. Volume can be plotted. Watch for disparity between the Nasdaq and the DJIA or S&P. The Dow cant make and sustain a bull market by itself, and the Nasdaq is likely to top out and go into a sustained decline before the Dow Industrials, as happened during 2000. And any rally in the Dow will not herald a major new bull market, unless the move is reflected in the Nasdaq. 15. Resistance Index. This has various styles and forms. An easy method is as follows: If the market is up (as measured by the DJIA), subtract the advances (total issues advancing) from the issues traded. Then, divide the figure by the total issues traded. If the market is down, do the same thing using the declines instead of the advances. This percentage shows the level of resistance to whatever the market is doing. This calculation can be made on a weekly or daily basis. Unless you are a day trader, the daily will serve no purpose for you. In the weekly form (using figures for the week as a whole and ignoring daily figures), it usually shows resistance between 30% and 60%. Normally, it stays well within the middle zone of those two extremes, but, when it leaps up or falls down to touch those levels, it is showing strong resistance. 16.Leadership Index. The average price of the daily volume leaders showsthe kind of leadership the market is enjoying. If this tends to fall onupswings or rise on downswings, its bearish. I like this indicator andhardly anyone follows it anymore, which makes it work better.17.Percent of advances index. Divide the daily advances by the issues traded. This is another way of approaching the overbought-oversold problem. A 10-day moving average is probably best. In charting it, youll discover how to interpret it, for the extremes become obvious cues. When it falls below 40%, its a signal of weakness ahead. 18. Gold Shares Index. This (as with most indices) can be kept daily or weekly, or both. If you are an active investor or trader, you need this on a daily basis. There are several Gold indices. The Gold-Bug index (my favorite), the Toronto gold index, the Financial Times gold index, and the South African gold index. Or you can create your own by posting the prices of at least six gold shares into a composite index. Compare the net change each time with the net change of the Dow Jones Industrials. If they both rise together, its bearish, especially if the golds net change is large. Also, when the gold index has a large net change and the DJIA moves in the opposite direction or moves down, the action is predicting the market will continue in the same direction the next day. SOME PERSONAL FAVORITE INDICES 1. DJIA 10-day moving average of internal volume. Dont tackle this one unless you like work. Here, you total the volume of all the Dow stocks that rose, and those that fell, separately. Make a 10-day moving average of the plus-volume and also of the minus-volume. Subtract these totals daily, and chart the differential as a plus or minus figure. Through the use of trend lines, this chart will show you blue-chip strength. Breaking a trend line is usually a valid signal. Other cues can come from normal chart formations. . DJIA resistance. Similar to above, but limited only to those DJIA stocks that were unchanged. This volume is posted on a daily basis only, not a 10-day moving average. On days when the unchanged volume is high, it is usually a fairly safe assumption that whatever the market did that day is wrong and will be reversed the next day. 3. DJIA volume ratio. Get the volume of all DJIA stocks. Divide that figure by the volume for the market as a whole. This percentage ratio represents what share the blue chips have of the market total. No canned explanation here will do, as experimentation brings the best result. But, loosely, a high ratio is usually bullish, a low ratio bearish, read against the market background. The range is about 8 to 14%. 4. Advance-decline 200-day line. Same principle as 200-day line for the DJIA or any stock, but its significance is often greater. The principle of 200 days is that this covers a long enough period so as to be representative of short, medium, and long-term investors thinking. A 1-year view is taken by a large number of people for tax reasons, and an index spanning this period thereby gains significance. 5. Nasdaq volume leaders. Record the plus and minus action of the top five Nasdaq most active stocks. You can chart it on a daily basis, or a 3, 5,6, or 7-day moving average basis, or weekly. I tend to interpret this one very loosely as giving a bullish signal on the first day (in many weeks) that it records five consecutive pluses and a bear market signal on the first five minuses. You can use this formula for the S&P and DJIA also. In general, I do not use indexes based on the Russell, or Wilshire, because these are not averages most investors watch. They are not the ones CNBC gets excited about. Though they give you a fuller picture of what the overall market is doing, their movements do not psychologically move investors to act. STOCK MARKET NOT A THING APART To many, perhaps most investors, the stock market is treated as a thing apart from life, not a reflection of our total world. Somehow, people believe it is perfectly logical for the stock market to rise while the business climate becomes antagonistic and/or riskier. Even in todays supposedly global, interdependent world, very few people consider happenings in other countries when buying American shares. But communications are so immediate that what happens in Tokyo or Brussels has a direct bearing on the stocks the guy in Kansas or Kentucky is considering buying or selling. It is only within a broad international economic/political/cultural context that you can successfully use your market tools. A knowledge of global economics, global politics, and global cultural considerations have become vital market tools. You should listen to daily international newscasts, and read at least one foreign daily newspaper. If you can read a foreign language newspaper, so much the better, but, if not, then the International Herald Tribune, or the Financial Times of London are prime choices. All foreign media give a global perspective in ways the US press never does! Unlike the US, most countries with credible stock markets are too small and vulnerable to live in the sort of insulated bubble of non-awareness that America has inhabited for most of its history. Only time will tell if the events of September 11, 2001 will cause the American media to produce more thoughtful, balanced and non-provincial news, of the sort the Financial Times or the nightly BBC News produces. But, as of this writing, there are few signs that anything has changed much. Provincialism still rules. VALUES AT BEAR MARKET BOTTOMS Too little has been said about values at bear market bottoms and at other turning points. It is one of our safest, if not best indicators. It refers to the percent of dividend yield of the DJIA stocks, and, as such, is a measuring rod for what kind of return or value you get for a dollar invested. At the September 1929 peak, the DJIA average yield was 3.3%. At the crash low, 2 months later, the yield was 5.2%. During the 1929-32 (and the great majority of all bear markets), higher yields came about through falling stock prices. The yields went from 3.3% to 10.3%. You cant know when yields are too high, or too low. But, if you are constantly aware of whether yields are relatively high (or low), you will keep your mind in a constant state of alert, so that stock action will fit into perspective and wont surprise you. It is often the surprise-shock that stuns investors and renders them incapable of making rational decisions when it counts most. A prepared mind is not caught off guard. TWO WARNINGS 1. If an indicator points to the market going up next, for example, dont assume it must be boxed into a period of precisely one full, precise market day. The market may rise sharply for the first 3 hours of the next day, then fall to the floor. The indicator was right as far as it could see within its limits. Ditto on a weekly basis. Youll learn these limits for each index with experience. Watch what happens regardless of time. Think in terms of points, not hours, weeks, or months. 2. Dont rely on indicators to work mechanically. Try to get the feel of the situation. Its not easy to come by. But, to whatever degree, however slight, you can attain that feeling, its worth the effort. It comes easy to some, hard to others, like learning languages. And this is a languagethe language of Wall Street. Learning to see or feel the relationships of the indicators or to sense the background against which they are talking at any given moment is the art of real stock market analysis. The seeds of every decline are planted during the late stages of every upturn, and it follows that the promise of a new uptrend comes into being during a decline. Its part of the job of your tools, or indicators, to detect these seeds. YOU CANNOT IGNORE INDICATORS Its a mistake to think you are too lazy or busy to bother with indicators, for in truth we are all index-conscious all the time in ways of which we are only vaguely aware. You are bound, for example, to be interested in at least a few from among those that pass before you automatically: Federal Reserve action such as interest rate cuts, figures on production, consumer confidence, cost of living index, or the percent of unemployed. Or your brokerage service provides indexes for you as a customer. Or the advisory service you get is keen on Bank Credit statistics or odd lots. You cant escape indicators. So this is my recommendation: If you cant fight em, join em. Instead of having statistics tossed at you randomly, often selectively by the media to build a case for their particular point of view, take control. Put them in some order to get perspective. Keep your own indicators so that when figures pop up in the press or conversation, you can fit them into an ongoing long-term pattern. Virtually all indicators have value. Its up to you to determine which ones best talk to you. And you may create new ones or variations of old ones that may be more effective than those in use today. And youll learn to weigh them on the basis of their degree of success in the past. Use as many as you can possibly spare time for. The greater the span of your indicators, the greater your understanding. Knowledge is power, now and ever more. AUTHORS WARNING One very important final and cautionary word belongs in this chapter. There is nothing wrong with indexes, but there is often a lot wrong with the interpretations some people make from them. So, if you read an advisory service or hear a broker say that such and such an index is now bearishdont believe it until you have checked it out yourself, on your own charts. That is, unless you have found from experience that this brokerage or that service knows that index well enough, that you are satisfied they are interpreting it correctly. Also, unless you analyze them yourself, you dont know if their interpretation is short, medium, or long term. KEY TO TECHNICAL SUCCESS The single most important key or guide to remember, in my opinion, in this area of using technical tools for buy-and-sell cues is this: The success of the technical approach can be realized only when the indicators are heavily weighted in your favor. Let me paraphrase that for emphasis. In working with indicators you have carefully been plotting for months, it is tempting to lean on them heavily and to act on their readings when you have, lets say, 6 saying buy, 3 saying sell, and 21 standing neutral. But, unless you have a truly heavy weight on the side of buy or sell (like 17 buy, 4 sell, 9 neutraldepending on which indicators you use and how you weight them), you cannot hope to succeed, on average. The same rule applies to individual stocks. Unless you can see at least the potentiality of a stock moving up 30 to 60% or more, it is not normally worth buying (except for scalp trading). Yet, people who know this and follow it in stocks will ignore the principle in their indicators. TOO MANY TECHNICIANS? Is there a danger that there can be too many technicians in the market? I doubt it. Provided you do your own analysis and dont just rely on some technical computer program that creates buy and sell signals based on their software, you will stay ahead of the crowd no matter how many other people use technical analysis. Technicians have an influence on stock action, and they provide leadership to a lot of non-technicians out of all proportion to their number, but they are not of themselves a big group. Its too much work (being a technician) for it ever to rise above the 10% level. And the number of really first-class, wellrounded, experienced technical-chartist-analysts with a moderately decent record of right guesses over wrong and the ability to express themselves is probably only a few hundred, in a world of millions of investors. |
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