Granville's Intermediate-Term Trading Model
(Intermediate-Term Indicators)
Granville's
55 indicators identify short-term pointers. He also has indicators meant to forecast movements on an intermediate time basis.------------------------------------------------------------------------------
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To his notion of an informed minority (as opposed to the uninformed public), Granville adds something he calls smart money (as opposed to money that, say, ends up in a rat hole). "Smart" money moves toward safety in a bearish scenario and goes toward risky stuff in a bullish situation. This money anticipates the movement of the general market.
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"Fleeing to safety" is the logic behind Barron's Confidence Index. The index points out the direction the market will take in the months ahead.
The Confidence Index:
represents the ratio between the average yield on Barron's 10 highest-grade corporate bonds and that on Dow-Jones 40 bonds (the ratio of primary to secondary bond yields). The ratio is high when investors demonstrate confidence by buying lower-grade liens, low when they take refuge in top-grade issues. Correlated with
the movements of the stock market, the Index becomes a highly sensitive forecasting instrument, predicting the extent as well as the timing of general price advances.Conversely, when more people are buying "junk" bonds, the denominator of the index decreases and the index itself increases, showing greater confidence in the economy.
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This index is a running record of market plurality, or breadth. It represents the cumulative differential between the daily advances and declines. So:
A plurality of advances augers well for a rising market and a plurality of declines underscores a weaker market despite the direction the Dow Jones Industrial average is moving in.
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The Index of Disparity is a comparison of the movement of the SP 500 with the Dow 30. It is a short-term indicator in that it records daily differences in the two averages, but it also has value as an intermediate-term indicator. It reflects the initial degree of market deterioration and suggests how far the Dow-Jones Industrials will go on the probable reaction.
The comparison is as follows. First, the SP 500 is multiplied by 10. For example, if the SP 500 is up on the day, say by 2.5 points, and the Dow 30 is down, say by 5.0 points, there is a bullish disparity of 25+5=30 points in favor of the Dow and the next move is expected to be an advance in the Dow. The principle is that the broader market is stronger than the Dow 30 and is likely to pull the Dow with it.
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A rise in the number of secondary offerings is an indication of smart money leaving the market. An offering frequently means sale of a large block of shares by a shareholder who "knows something." Such a sale can be made under cover of a legitimate offering. It could mean things don't look rosy for the future and it's time to exit.
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The Short Interest is reported only once a month, so the Short Interest Ratio can't be a day-to-day indicator. It does, however, rank high on the list of intermediate pointers.
The short interest itself indicates the number of shares that are sold short and measures bearish sentiment. In line with the theme that not everybody can be right, when the bearish sentiment gets too popular it is likely misplaced. The market is then probably oversold and on the verge of a major reversal, leading to higher prices.
The Short Interest Ratio, which is the ratio of the monthly reported short interest to the average daily volume for the month, would be decreasing, as well. The ratio, then, more than the number, reflects the importance of the short sales.
Whenever the ratio rises to above 1.5, bearish sentiment is being overdone and rising prices lie ahead. Whenever the ratio falls under 1 it indicates that the market technical position is weak and that a decline in prices lies ahead.
Understood in its relative sense, the indicator provides the following rule:
(In) the majority of cases following a decline in the market, the turn is first signaled by either an upturn in the short interest coincident with that of the market or an upturn in the short interest taking place prior to the market advance.
In the case of a rising market:
Significant market downturns never take place while the short interest is rising and therefore the first evidence of a sustained downturn in the short interest is a major market warning.
Unfortunately, however, there are two kinds of short sales -- technical and fundamental. Technical short sales are made by traders who are quick to take their profits. The short covering quickly bolsters the market.
Fundamental short sales, on the other hand, are made by people who see fundamental problems in a company and believe the stock is in for an extended price decline. This means they don't provide an immediate prop to the market, which could decline considerably more before short covering generates technical support. So in a bear market, reliance on the short interest as a technical indicator for the purchase of equities could be unrealistic.
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