Trader’s Narrative

A few days ago I featured the charts of the new 52 week lows for the Nasdaq and the NYSE showing that we’d have to go back all the way to 1998 to find higher extremes.

Contrary to what some might suspect, a spike to record heights in fresh stocks plumbing the depths of annual lows is actually good news for the stock market. It means that we have a washout of selling, a euphoria of panic. That is where the market finds its legs again.

But one of the comments I got was that since the number of stocks trading changes over time, this isn’t a very valid argument to make. For all we know the only reason there was such a record now is that we simply have more stocks trading and therefore more probability that of that population, a higher sample would hit 52 week lows.

Makes sense to me. So to check it out I looked at another set of statistics: the ratio of new highs to new lows.

If we follow the same argument, of the larger population of stocks being traded, there should be as much chance of stocks hitting new 52 week highs as 52 week lows. So by comparing the ratio of the two, we can normalize over time and compare apples to apples.

Note: I’ve inverted the charts to make it similar to the new 52 week lows chart I showed previously - so a spike up marks a bottom

Ratio of 52 Week Highs to 52 Week Lows for the Nasdaq:

Ratio of 52 Week Highs to 52 Week Lows for the NYSE:

So we can rule out that anomaly. It seems that the extreme reading is legitimate. Although I would take the NYSE data with a wheelbarrow of salt since more and more non-common stocks (but rather interest rate sensitive synthetic securities) are trading there.

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.

On light volume, the market closed strongly down today ahead of the US Thanksgiving holiday. The action brought about an acceleration in the number of new lows (52 week) relative to the number of new highs.

The ratio of new highs to new lows is one of my favourite technical indicators because it has an uncanny predictive power. Like the majority of breadth indicators, it is much more accurate in finding bottoms than peaks.

The last time I mentioned this indicator, I highlighted its cousin the new highs/new lows indicator which is a slightly different way to look at the same data to make it normalized on a 0-100 scale.

At the beginning of August it had flashed a critical level which presaged the summer to fall recovery. Right now it is even lower than the minimum it reached in mid-August 2007.

Here is a chart showing the ratio of Nasdaq new 52 week highs to new lows since 2000. Notice how the spike lows match every significant market bottom:

Of course, the reason why this indicator has such predictive qualities is that it highlights when the market is near a “wash out” stage where all the weak hands have sold and there is a total disequilibrium in sentiment.

I don’t think we’re at an inflection point just yet but we are darned close. So keep your powder dry and sleep with one eye open.

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:

The new high, new lows indicator looks at the number of stocks within a group (say the S&P 500 or the Nasdaq) making 52-week new highs and new lows. It ranges from 0 to 100. The low ranges mean a lot of stocks making 52 week lows and not many making 52 week highs. And the high ranges mean the reverse.

As you imagine, this sort of information can be very useful at finding inflection points. When the market is very oversold, we usually find a lot of new 52 week lows relative to 52 week highs. So keeping an eye on this indicator is useful.

After today’s lackluster trading, this indicator for the Nasdaq fell more than 38 points to just under 30. This is low but still not extremely so. If the market drops again, it will push this indicator low enough that we would set up for a bounce higher.

Of course, within a strong bull market shallow retracements are more prevalent. So we could recover without any further damage. But for a really nice intermediate bottom, I’d prefer to see a reading of 10 for the new highs, new lows indicator.

Anyway, I wanted to point this out ahead of time because I prefer bring to your attention things which may be actionable. It may set up or not. But in either case, its more useful to talk about possibilities than point them out after the fact. Hindsight is 20/20.

Here’s the chart for the past 3 years. Note that while the Nasdaq’s chart is weekly the indicator’s chart is daily:

The other insteresting data point comes from the options market. The put call ratio (equity only) spiked significantly higher today but didn’t reach extreme levels. Similar to the new highs new lows indicator, if we have another bout of selling like today’s, the put call ratio will get there.