Trader’s Narrative

One of my favorite breadth charts is the Bullish Percent Index. It isn’t as common as advance decline measures because it is based on point and figure charting.

Point and figure charting itself is based on pure price action and ignores both time and even small price movements. In P&F charts the X represents demand (or bid or buying) and the O supply (or selling). Unlike candlestick or bar charts, it is perfectly normal for a point and figure chart to not need to be updated (when price doesn’t move beyond a threshold either up or down). This is the great advantage of point and figure charts.

Other than that, the basics of technical analysis such as support and resistance apply to point and figure charts. Also, point and figure charts can provide systematic buy and sell signals - something that ‘normal’ charts leave open to the traders discretion. The simplest buy signal is the chart to the left - when price breaks above a previous high (without the column of O’s breaking below their previous low).

So to calculate a Bullish Percent Indexes, we simply take a look at each and every stock compromising an index and track how many of them out of the total constituents are in a point and figure buy signal. If, 120 out of the 500 stocks in the S&P 500 index are in a buy signal for example, then the Bullish Percent Index for the S&P 500 for that day would be 24%.

Doing this by hand would be extremely cumbersome, but thankfully we have computers that can do the calculations in a fraction of a second. Here is the chart of the Bullish Percent Index for the Nasdaq Composite:

According to the traditional interpretation, a Bullish Percent Index of 70% and higher is considered overbought. And if there it experiences a 6% (or more) decline, it will offer a sell signal. Personally, I prefer to not wait for the sell signal. Once you know that the market has weak legs, you can use other indicators to give you more short term guidance.

Right now we are seeing almost every single measure of the market provide extreme breadth levels from the Bullish Percent Index. Normally seeing the bullish percent indexes for so many markets and sectors reaching this high in synchronicity would be a red flag. However, there is an argument for such strong momentum to be a signal of a protracted rally.

This was the same concept that I shared earlier this week about incredibly powerful thrusts measured from the advance decline breadth. These short busts of powerful buying are usually precursors to lasting uptrends. Think of it as a turbo booster on a rocket which lifts it through the heavy atmosphere before it can glide easier through the thin air of space.

Consider that the last time the Nasdaq composite BPI was this high was back in 2003-2004 during a powerful bull market. It is the same case for the NYSE, and the Nasdaq 100 index. This is how oversold can become meaningless.

Bullish Percent for Major Indexes:

• NYSE Index — 77%
• Standard & Poor’s 500 — 83%
• Nasdaq Composite — 70.55%
• Nasdaq 100 Index — 90%
• Dow Jones Industrial — 77%

Bullish Percent for Sectors:

• Financial — 86%
• Consumer Discretionary — 79%
• Consumer Staples — 73%
• Energy — 60%
• Healthcare — 79%
• Technology — 87%
• Industrial — 71%
• Materials — 85%
• Telecom — 56%
• Utilities — 62%
• Transportation — 75%

If you’re not familiar with Bullish Percent charts or how they are calculated, check out my previous post on How To Time the Market With Bullish Percent Charts. I use them to find inflection points, which is different than their creator’s intention.

The Nasdaq Bullish Percent Index reached a recent high of 51.36% and more importantly, it has hovered at or above the 50% level for 5 consecutive trading days:

Even more alarming, this is the corresponding level that we last saw in October 2007, just as the brutal bear market was about to descend into Wall St. In the past 10+ years, the Nasdaq Bullish Percent Index has had a tough time going higher than 50-60%. The only exception was in 2003 when we saw BPI pushed to 78% by the powerful new bull market.

So not only are we back to Bullish Percent levels where the bear market started, we are at levels which have historically marked tops in the equity market. The only justification for new long positions here, or continuing to hold on to existing long positions, is the expectation that we are going to see yet another powerful non-stop rocket ride as in 2003.

Anything is possible but considering everything, I think that scenario is highly improbable.

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After flagellating myself for too much bearishness, the last time I wrote about the yellow metal I mentioned that I would be returning to it when it presenting a buying opportunity:

The best combination of breadth is strong long term (200 day average) and weak short term (10 and 50 day moving average). A good example was in mid December 2007 when there were only 10% trading above their 50 day MA and 5% above their 10 day MA with a very high 60% above their 200 day MA.

I’m keeping a wary eye on this sector until it presents a similar setup and will post about it.

After its top in March, the Philadelphia Gold Bugs Index (HUI) fell almost 20% in the span of a few weeks. And since I was distracted, I missed the opportunity to write about arriving at the exact oversold condition that I described above.

But since things haven’t significantly changed in this sector, let’s have a look. The commodity itself fell from a high of almost $1034 to $876 and it pulled down gold equities with it:

Gold Sector Breadth
We now have almost 60% of gold stocks trading above their 200 day moving average. So as described above, the long term is still in good shape.

And the short term is weak: in early April, only 10% were trading above their 10 day moving average. Similarly, only 20% were trading above their 50 day moving average.

Since then of course, they have moved up slightly but neither is so far extended to remove the oversold opportunity.

Gold Bullish Percent
The recent decline in the Philli Gold Bugs Index (HUI) also caused the bullish percent index (BPI) for the sector to kiss the 30% line iin early April 2008.

Historically, when the bullish percent falls to this level or lower it is a good time to “rent” some gold stocks. The previous instance was in January 2008.

Since there is nothing magical about this 30% area, the BPI can crash through it to reach significantly lower levels. For example, in October 2007, the gold BPI fell to almost 15%.

Getting back to today’s conditions, since earlier this month the BPI has recovered along with gold and gold equities. But we are still at a low enough stage that catching and riding a rally are possible.

Gold Sentiment
According to Mark Hulbert, the newsletters that write about gold and time this sector are now quite bearish. The Hulbert Gold Newsletter Sentiment Index (HGNSI) is now at -17.2% - meaning that these newsletters are now actually recommending their clients short the market.

While the all time record for pessimism comes in at -31.3%, this measure of gold sentiment has been lower than the current reading only 2% of the time in the past 20 years.

Since gold is clearly in a secular bull market, such a quick retreat after a ~20% drop shows that there is a complete lack of stubbornness on the part of the gold bulls. Which from a contrarian measure is very promising for the continuation of the gold bull market.

So when you have breadth, bullish percent (an alternative measure of breadth) and sentiment all congruently pointing one way, you have a pretty good chance for a profitable trade.