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Momentum and Sentiment Indicators

Tom Ventresca
Tom Ventresca
Market Edge.com
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Fourteen daily charts and graphs which show the market in motion.

'Market-At-A-Glance', the latest addition to the Market Edge site (www.marketedge.com) is a comprehensive view of the market in action. It contains fourteen daily charts and graphs of major market indexes and pertinent technical indicators. The result is a complete picture of the market and its components in motion and can be a valuable tool in determining the future direction of the DJIA.


The following is a list of the indexes and indicators that are included in the Market-At-A-Glance section.


Dow Jones Industrial Average (DJIA)Russell 2000
Dow Jones Transportation Index (DJTA)U.S. Equity Mutual Fund Cash Inflows
S&P 500 (SP-500)NYSE New High/New Low Line
New York Stock Exchange Index (NYSE)CBOE, Index Put/Call Ratio
NASDAQ Composite (NASDAQ)NYSE Advance/Decline Line
NASDAQ Advance/Decline LineNASDAQ New High/Low Line
CBOE Volatility Index (VIX)% Bullish Investment Advisors

All of the components listed above are included in either the Market Edge Momentum or Sentiment Indexes and are used in conjunction with the Cyclical Trend Index (CTI) to form our market forecasts.

Comparing the charts of the major market indexes (DJTA, SP-500, NYSE, NASDAQ, Russell 2000) to the chart of the DJIA provides confirmation or non-confirmation of a DJIA move, whether up or down. A confirmed move by the DJIA would result in similar looking charts of the majority of the other indexes. Conversely, a non-confirmed move by the DJIA would show a lack of participation by the other averages.

When the Dow 'walks alone', meaning that the bluest of blue chip stocks are making new highs while the broader based indexes are not, a major reversal is usually in the cards. On the other hand, when the DJIA records a series of new lows, which aren't accompanied by similar movement of the broader indexes, a reversal to the upside is imminent. Typically, the market will experience a series of confirmed highs or lows over an extended period of time.  When this occurs, the market is telling you that it is in either a long-term bullish or bearish trend. When non-confirmed moves begin to develop, the market is sending a signal that a change in the prevailing trend is in the making.

In addition to the six market averages, there are eight technical and breadth indicators plotted for similar analysis. The breadth indicators include the NYSE and NASDAQ Advance/Decline Lines and the NYSE and NASDAQ High/Low Lines. Breadth indicators measure the broadness of the market's participation in either an up or down move. Both of these indicators are constructed in the same manner. The A/D Line is a running total of the number of advancing issues minus the number of declining issues. The High/Low Line is a cumulative total of the number of stocks making new 52-week highs less those making new 52-week lows.

When analyzing breadth indicators, look for positive and negative divergence by comparing the performance of the indicator to that of the DJIA. Negative divergence occurs when the DJIA is performing worse than the breadth indicators. This is easy to spot on the charts, as the DJIA would be trending up while the breadth indicators are turning down. This typically occurs at significant market tops. Positive divergence is the opposite situation. The DJIA is in a downtrend while the breadth indicators begin to turn up and usually occurs at major market bottoms.

The remaining four indicators measure the market's sentiment. These are contrarian indicators meaning what appears to be positive is actually negative for the market. The sentiment indicators include CBOE -VIX, Put/Call Ratio, % Bullish Investment Advisors and U.S. Equity Mutual Fund Cash Flows. The theory behind sentiment indicators is simple. When market participants become either extremely bullish or bearish, the odds are that the market will go in the opposite direction. The reason for this phenomenon is as follows: If the majority of traders are bullish, they have expressed their opinion by putting all of their money to work in the market, thus leaving little cash available to fuel the fire. Conversely, when sentiment is very negative, traders have liquidated their positions, which eliminates the supply of stock for sale. This lack of selling pressure coupled with a build up of cash creates a perfect scenario for a significant rally to develop.

The majority of the time, these sentiment indictors are flashing neutral readings. However, when market sentiment swings dramatically to either the bullish or bearish camp, these indicators will signal that a market reversal is at hand. Each indicator has a range of values, which are listed below along with the extreme bullish and bearish areas for each indicator.

  1. CBOE Volatility Index (VIX): A measurement of the premiums of index puts and calls. Range can vary from 0 to 100. Readings under 20 are regarded as bearish as option premiums shrink and complacency takes over the market. Readings over 30 are bullish, reflecting an increase in put option premiums as an aurora of fear permeates the landscape.
  2. Index Put/Call Ratio: A five day average ratio of the number of Index put options divided by the number of call options traded on a daily basis. The range for this ratio typically varies from .70 to 2.50. Readings over 1.70 are regarded as bullish, reflecting a very high number of puts being purchased versus calls. Under 1.00 is bearish since it indicates that either an equal amount of puts and calls are being bought or more calls than puts are being purchased.
  3. Percentage Of Bullish Investment Advisors: On a weekly basis, Investors Intelligence, Inc. reports the percentage of newsletter writers who are either Bullish, Bearish or see a Correction for the market over the intermediate-term horizon. Typically, the percentage of advisors with a bullish outlook ranges from 30% to 70%. Readings under 40% are regarded as bullish while those over 55% are bearish.
  4. U.S. Equity Mutual Fund Cash: Money makes the market go round and round. Monitoring the amount of cash that is either coming in or going out of U.S. equity funds is a good measurement of investors sentiment. When outflows approach record levels, a market bottom is in the offing. Conversely, when money is pouring into equity funds for a sustained period, a major top is imminent.

The Market Edge Momentum and Sentiment Indexes track these indicators on a weekly basis and collectively with the Cyclical Trend Index (CTI) form the Market Edge "Market Posture". The Momentum Index produces a numeric value, which can range from +10 to –10. Positive numbers occur when a majority of the indexes are outperforming the DJIA on a percentage basis when compared to their previous cyclical low or when they decline less than the DJIA when compared to the indexes previous cyclical high (positive divergence). Negative numbers follow a scenario whereby the index underperforms the DJIA when compared to the prior lows or when the majority of the indexes decline more than the DJIA when compared to the prior highs (negative divergence). Readings over +3 are regarded as bullish while readings under –3 are deemed to be bearish. The Momentum Index is updated weekly and is located at the top of the Market Edge "Market Letter".

The Sentiment Index incorporates the above indicators with five additional sentiment measurements to reduce the overall market sentiment to a number that can range from -6 to +6. Readings over +2 are regarded as bullish while those under 0 are bearish. The Sentiment Index is also located on the top of the Market Letter.

Tom Ventresca will be available to take your questions until Monday, October 17. Please use the form below to submit your questions.

 
 
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