Trader’s Narrative

If you’ve read this blog for some time you know that I’m a great fan of popping the hood on price and looking at what is really driving the market (Market Internals). One great indicator is the advance decline number which shows you, on any given day, how many stocks closed up and how many closed down.

Since this indicator can have wild swings from one extreme to the other the daily chart looks too “noisy” to be of any value. We can take out the noise by using a moving average or we can calculate a running total by adding each successive day to the previous and make it a cumulative indicator.

Here’s a typical way that this indicator is used (see graph on left). It comes from Michael Panzner who writes in the AOL money&finance blog.

He concludes from the graph that “since mid-April, this popular measure of market breadth has been something of a laggard, despite the fact that the technology-laden index has been trading near multi-year highs.” While not calling for a crash, he says that this means that the bulls will have to “tread carefully” because the “market lacks the broad participation necessary for a sustainable advance”.

Sounds reasonable, right? Let me show you why its incorrect.

First of all, we have to step back and take more data into consideration.

The graph below shows the Nasdaq cumulative advance decline numbers from around September 2005 to today. The red box contains the graph that Panzner shows above:

Things sure look different now, don’t they?

Negative divergences are all over the place. But the market actually goes up. In fact, if you keep going back historically you find that this is the norm. The long term Nasdaq cumulative breadth index looks like a ski hill with a few moguls here and there pausing the decline momentarily.

Very strange. Logic would seem to dictate that a stock market needs advancing stocks to power ahead. So why is it that we see a disconnect between a persistently falling cumulative breadth with lower lows and lower highs, and the market?

Believe it or not, there is a very good reason. But it is not apparent to everyone. It sure wasn’t apparent to me either. A few years ago when I noticed this strange and persistence divergence I contacted one of the best technical analysts that I knew: Helene Meisler. She was kind enough to school me.

From that point on I never bothered looking at a cumultive breadth graph again (until now) and instead used the moving average of advancers and decliners.

I’m surprised that Michael Panzner, who is as his blurb claims, is a 25 year veteran of the markets, doesn’t know. Or perhaps he does and purposefully cuts off his graph (red box above) at just the right spot to buttress his claim.

Hmm… do you think it might have anything to do with the fact that Michael Panzner is the author of “Financial Armageddon: Protecting Your Future from Four Impending Catastrophes“?

Such bombastic predictions may sell books but they won’t do much for your portfolio.