Trader’s Narrative

Here’s yet another market indicator which is suggesting caution. I’ve been noticing these pop up for a while now. And although we have now broken above the problematic resistance level of 1400, there are several reasons to reign in any rampant bullishness in the short term.

Among them, sentiment as well as the High/Low Indicator that I’ve mentioned before a few times. It measures and compares the number of highs to lows in the S&P 500 index. It is a ratio of the highs to the sum of the highs and lows. So when it is a low number, we know that there are ample lows but little or no highs. And the reverse when it is a large number: many highs with few lows.

Like many others, this metric is much better at pinpointing a bottom than top. This year has already brought two crazy oversold situations in the market. The first in January and the second, mid-March. You have to remember the blue line in the above graph is a moving average, which means that we spent many days with a tonne of new 52-week lows and zero 52 week highs.

At the same time, we aren’t yet pushing the other extreme. Clearly the extraordinary situation in early 2008 has been resolved and the S&P 500 has bounced back - around +10%. And even if the High Low Index did get red-lined, it is no guarantee that the S&P 500 will top out instantly.

But the important thing I take from this metric is that we no longer have that deep oversold condition from which to catapult higher. Been there, done that. The easy money has been made in that trade. Now the longs have to keep their wits about them.

Let’s see if the new high-new low indicator can do it again.

About a month ago (November 21st to be exact) I noticed that the new high-new low indicator was flagging an inflection point in the market.

As a quick refresher, the new highs-new lows indicator is calculated by taking the new highs in an index or market and dividing by the sum of the new highs and the new lows.

Anyway, here’s what I wrote then:

On November 21st the S&P 500 index closed at 1416.77 (green arrow) — within two days, the market action took the index down to 1407.22 (on November 26th). And that was it.

From there on it started to climb. Except for a slight pause, it went all the way to 1520.

Not a bad call at all, if I do say so myself

So let’s see what the same indicator is saying now:

Yesterday’s close took the indicator for both Nasdaq and the NYSE down to less than 5%. Those are abysmally low numbers which means we are very oversold and close to an inflection point.

About two weeks ago I brought up an indicator, the New Highs/New Lows on Nasdaq eventhough it wasn’t really telling us anything interesting back then. It is a ratio measure of stocks within the Nasdaq making 52-week new highs and new lows. It is a percentage so it ranges from 0-100%. When it is low, it means that very few Nasdaq stocks are making new highs while the vast majority are making new lows.

Back then it had fallen to 30%. Low but not really extreme. It was worth watching because of its uncanny ability to find market bottoms.

As I mentioned, for a good solid floor under the market this indicator needs to reach atleast 10%. In the past, this level has coincided with significant market bottoms.

As a result of last Thursday’s heavy downday, this indicator finally breached the 10% line in the sand to hit 9.4%. On Friday, eventhough the market continued to sell off heavily, this indicator surprisingly went up 2.18% percentage points.

Which means that while the indices were getting clobbered Friday, actually less stocks were hitting 52 week bottoms and more were making 52 week highs. This is the sort of divergence that I’d love to see more of.

I didn’t include a chart of the S&P 500 but I’m sure you recognize all of those points in time with the green arrows as major market bottoms.

Last week the Nasdaq new highs, new lows indicator was just under 30 and I mentioned that although it had dropped it had yet to reach an extreme level which would presage a bounce.

After yesterday’s red day, it fell to just under 15. That’s low, but still I’d like to see it reach below 10 and move higher. In the past this is what we’ve needed to set up an intermediate bottom. For detailed information on this indicator, check this out.

Such a reading would mean that almost 90% of the stocks reaching 52 week extremes are doing so by hitting new 52 week lows.

Another way to look at the same sort of data is to look at the Nasdaq high/low ratio. That is simply divide the daily Nasdaq new highs by the daily Nasdaq new lows. This indicator shows pretty well the same thing. The market is oversold, but not yet to an extreme level.

We may get a feeble bounce today as the market reacts but for a really good washout, we need more work to the downside. That may happen quickly or over the next few days and into next week.

However it works out, atleast through the looking glass of this indicator, we aren’t there yet. As you can see on the graphs below, we need to reach the green areas outlined:

Nasdaq New Highs New Lows Indicator:

Nasdaq New Highs Lows Ratio: