Diverging Indicators: Treat Them As Suggestions, Not Rules

This is pretty typical of the type of market we’re in as we have some conflicting signals that will be worth keeping track of. One indicator has us historically overbought while the other suggests we’re nowhere near topping levels. I think one has to consider where we’re at right now given we’ve just had one of the worst sell-offs in the stock market’s history and use these indicators as suggestions, not absolute rules.

On Wednesday we had the most stocks on the Nasdaq hitting new highs than we’ve had in months and it’s still at major lows when you compare it to what it’s done over the past 3 years. We have lots of room to the upside here to move higher, although that isn’t a given and we could just as easily turn lower when the big boys come back after the new year (click on chart to enlarge).

At the complete opposite end of the spectrum you have the McClellan oscillator hitting historic highs. Greg Morris author of The Complete Guide to Market Breadth Indicators has this to say about this indicator:

In my recently published book “The Complete Guide to Market Breadth Indicators,” I identified the McClellan Summation Index as the most valuable breadth indicator of the 80+ ones that I researched.
Why?
Its primary component, net advances, provides an excellent measure of the market’s liquidity. The direction and level of this indicator are exceptional at identifying good and bad investment climates. For example, research from PMFM, Inc., showed that whenever the McClellan Summation Index is above zero, rarely do any “bad things” happen in the market; most of the “bad things” happen when it is below zero. This is a valuable piece of information and should be part of every analyst’s technical model.

I really have no way of knowing which of these will be right and only in hindsight will we be able to look back and say, “It was so obvious that indicator was correct.” Use these in conjunction with other signals your chances of success should increase and pay close attention to which indicator reverses for clues (click on chart to enlarge).

Comments

[okl:]

yep, tracking the NYMO as well... its pretty hot at the moment.

today will be another sloooow day, the real action starts next week.

mean while, happy new year to all.

Jan 02 07:58 AM

[1977°C:]

In the bear market no indicator works, we are long way before the market bottom.

Jan 02 11:02 AM

[BrucePile:]

The McClellan Oscillator does tend to dip below 0 before the worst parts of the sell-offs. But an extreme high very typically comes before major moves down. If you look at the last year, you had highs (over 40) at the following points:

Date Oscillator Market Action That Followed
Feb. 1 70 9% decline over next 5 weeks
May 15 40 15% decline over next 2 months
Aug 30 60 31% decline over next 5 weeks
Nov 1 100 25% decline over next 3 weeks
Jan 2 108 ?

I guess the moral of the story is a high reading means it's safe to be in the water, but the day it crosses 0, head for the beach.

Jan 02 10:38 PM