Indicators of Market Trend
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The ARMS Index
Created by Richard W Arms, this index attempts to take trading volume into account as a market predictor. The index is expressed as the ratio of two ratios. The numerator is the ratio of price advances to declines for a given period, like a day, and the denominator is the ratio of the advance volume to the decline volume.
Treated as an oscillator, the index signals a bear trend ahead when it gets small, i.e., when the advance volume is large. And it signals a bull trend ahead when it gets large, i.e., when the down volume is small. Note that the denominator is small when the down volume is large.
An increase in volume is important to sustain a bull trend. It is only when the volume becomes excessive -- the so-called blow-off level -- that the direction change is signaled.
The Dow Theory
To signal a market trend change, the theory requires that:
See The Dow Theory for more details.
Head and Shoulders Reversal Pattern
For details of this chart pattern indicator, see the Head and Shoulders chart pattern.
Linear Regression
This indicator has the same effect as a moving average. For details, see Regression and Correlation.
Market Bellwethers
Bellwether stocks are stocks that lead the market. The indicator might check the state of stocks like General Motors, General Electric, IBM, or Microsoft. The rule is, if GM (etc.) doesn't fall to a new low within a four-month period, the market should move higher. If it fails to establish a new cyclical high within a four-month period, the market should trend downward.
MAC-D
The Moving Average Convergence/Divergence (MAC-D) indicator is based on a divergence of the difference between two moving averages and stock price. See Moving Average.
A moving average measures the direction of a market trend. A moving average is a running average of prices over a fixed interval of time. To find a ten-day moving average, for instance, on each day compute the average price for the previous ten days. You progress by dropping the oldest price and adding the new one. Since trends tend to persist, a rising average is bullish, while a declining average is bearish.
Note, however, that a moving average is late by half the length of the period over which the average is taken.
Negative and Positive Volume Indexes
Reflecting accumulation of stocks by smart traders, the Negative Volume Index measures the trend of stock prices during periods of declining volume. Unsophisticated investors usually buy when they are exuberant, and this commonly happens when they have money and are talking about the market. Volume is then high.
Ohama Titanic Syndrome
There are four parts to this indicator, which reads the market's top or bottom turning points.
The signals for a top are:
The signals for a bottom are the mirror image of the above.
Percentage Rise of Standard & Poor 500 in Five Years
This index makes a percentage-wise comparison of the S&P500 prices five years apart. So at each time point it computes the percentage gain or loss of the current price over the price five years ago. For example, say the S&P was 1000 at one point and 1200 five years later. In this case, there is a gain of 20 percent.
A value of 200% is bearish. This was the value reached just before the 1987 crash.
Utility Stocks
Utility stocks are sensitive to interest rates and reflect developments in the bond and money markets, so they are leading indicators of market trends. Because utilities are changing their spots, though, they may no longer be so sensitive, so this index may now be suspect.
Volume Indicators
This index gives the relationship of volume to price movement. The underlying principle and value of this index is that volume precedes price. Tests of price histories indicate that the price and volume tend to move together. When one increases, the other does, as well. When one decreases, then so does the other. Therefore, a combination of rising prices and rising volume is bullish.
Contrariwise, climaxes in buying are bearish, whereas climaxes in selling are bullish. The former occurs in the final stages of a long advance, and the latter occurs after a long decline. Often what happens after the climactic volume in a bull market is a further rise to new highs on reduced volume; this is bearish and is common in Head & Shoulders topping patterns. In the climax of a bearish trend, lower prices on lighter volume is bullish and is common in inverse H&S patterns.
For the shorter term, though, declining volume on a correction to a bullish trend is bullish, and declining volume on a correction to a bearish trend is bearish. So you must be sure to distinguish between the general trend and corrections to the trend when interpreting the volume. See Cycles or Elliott Wave Theory for more detail on the ups and downs.
Volume Oscillators
These indicators compare the short-term volume with the long-term simple moving average of the volume. For example, it may compare the one-week data with the moving average of the 40-week data. When the volume for the short-term crosses the long-term simple average, a change in trend is indicated. For more details, see Volume Rate of Change.
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Advisory Sentiment Index
This index is based on the sentiment of professional market advisors and reflects the fact that stock market advisory services are usually wrong in the aggregate, though they are usually correct during sustained market trends -- much as weather reports are more nearly correct during unchanging weather periods. The Index measures the proportions of stock market services that are bullish and bearish on future trends. The proportions are most bearish during market bottoms, and most bullish at market tops. Like volume, they get louder at tops and quieter at bottoms.
Consumer Confidence
The long and the short of it is that high consumer confidence is bad for stocks, unfortunately. The consumer reaches new heights in confidence when the economy is strong and almost everyone has a job and money to spend. But that's usually the beginning of the end of bull markets. In other words, we tend to buy at retail, when everybody else wants to buy, sending prices through the roof. We tend to get caught up in the buying or selling mood of the public.
Corporate New Stock Offerings
Similar to secondary offerings, this indicator reflects the dollar amount of new corporate offerings of common stock to the public. Most offerings occur at high prices, so a high volume of offerings is bearish, while a very low volume of offerings is bullish.
Corporate Secondary Offerings
A secondary offering is usually considered bearish for a stock. So the larger the number of secondary offerings in a market, the more likely the market will go down.
Corporate Stock splits
Stock splits
occur only after stock prices have risen to values too high for easy sale. So when stock splits are filling the news pages, it's time to sell.
Credit Balances
This is the amount of cash carried on the books by investors in both cash and credit accounts. In sustained moves, rising credit balances can be bullish, because it indicates that investors are building up accounts by selling their stocks, which usually occurs too early, as the market continues to go higher. On the other hand, depletion of the accounts can be bearish when due to buying shares too early in a declining market, as the market continues to go down. Most unsophisticated investors tend to sell too early or buy too early.
The Fosback Index (The Fund Timing Index)
This is an adjustment mechanism that factors the level of interest rates out of the mutual fund Cash/Assets Ratio and calculates the percentage of cash holdings relative to total assets in a manner that reflects only the fund managers' stock market judgments.
High Low Logic Index
Invented by Norman G Fosback, this index is the lesser of the following two percentages:
When the Index is high, the market is in a period of great divergence, with many new highs along with many new lows. This isn't conducive to higher stock prices.
Industry Group Diffusion Index
This index measures the proportion of individual factors under analysis that are moving in one direction. For example, if you were looking at the twelve leading economic indicators on the so-called short list of the National Bureau of Economic Research, and found that nine of them were rising, the proportion would be .75. When the index is expanding across the board of indicator groups, the outlook for stocks is bullish. When the index is contracting, the outlook is bearish.
Member Off-Floor Balance Index
This "once in a generation" index measures trading activity by all members of the New York Stock Exchange other than specialists and floor traders. The key is that massive buying is massively bullish, but this phenomenon happens very infrequently. Putting it bluntly, these guys know when stocks are cheap.
News
Spur of the moment action on the news of the day is seldom a profit making business. But a correct, long-term reading of the news -- its significance -- could be rewarding. It means you have to be well informed.
Non-Member Short Sales Ratio
In the gambling business it pays to bet against habitual losers. One group of frequent losers is the non-member short seller -- the so-called public short seller. The idea is to bet against public short selling. When the public gets bearish enough to substantially increase their short selling, it's time to buy. And when the public gets so bullish as to reduce their short selling to a trickle, it's time to sell.
Odd Lot Balance Index
Given by the ratio of odd lot sales to odd lot buys, this index indicates a strong bullish trend at high readings, especially when it's used in a 10-day moving average.
Odd Lot Buying and Selling
Trading in odd lots
refers to the purchase or sale of less than a hundred shares of stock. Such trades are normally initiated by small investors, who, more often than not, unfortunately, are not well informed and usually wrong. So the directive is to do the opposite!
Public Short Sales Ratio
Non-member short sellers (the uninformed public) are notoriously wrong with their short sales, so the rule is to bet against them. When the public short sales ratio is highest, the market is normally at the bottom, and when it is lowest, the market is normally at a top.
Put/Call Ratio
Just as it states, this sentiment indicator is a ratio of the number of puts to the number of calls. It is regarded as bullish at extremely high readings. As a measure of the sentiment of the speculative option investor, it is usually wrong. So a high reading shows that the speculator is bearish, which means that the market is likely to continue to climb. At the other end of the scale, the market has likely seen its top.
Short Interest Ratio
You find the short interest ratio by dividing the mid-month NYSE short interest by the average daily trading volume on the Exchange for the previous four weeks. High ratios have normally been followed by rising prices, and low values have normally been followed by falling prices. The key is that short sellers are usually wrong at key market turning points, and short positions can only be covered by purchasing stocks.
Short Term Trading Index
This index measures the concentration of volume in advancing and declining stocks. The idea is, if more volume is flowing into the average advancing stock than into the average declining stock, the situation is bullish for the market. But if more volume is going into the declining stocks, it is bearish.
Specialist Short Sales Ratio
Specialists tend to short stocks at their price top, so a high specialist short sales ratio tends to indicate that the market is headed downward. I.e., the "smart money" is getting out.
The Speculation Indexes
Speculation indices reflect the degree of market speculation. For example, indices like the ratio of the American Stock Exchange volume to the New York Stock Exchange volume are speculation indicators. The more speculative they get, the more bearish they are. Conversely, when the ratio drops, they become more bullish.
Stock Margin Debt
When investors buy on margin, they usually borrow money from the broker. Margin investors are often considered to be sophisticated traders, and the extent to which they are margined is the property of interest. These guys are generally overextended at market tops, just when they shouldn't be. And they are under extended at bottoms -- when.they should be in heavy.
The Stock Margin Debt Credit Balance Indicator
If the trend for both debt and credit is down, it is very likely that a bear market is in progress. If the trend for both is up, very likely a bull market is in progress.
Total Shorts to Total Volume Ratio
This ratio reflects the sentiment of the short-sellers. Historically, when the ratio has been high, market prices have risen, and when low, prices have fallen. The ground is that market participants tend to overdo short selling at bottoms and fail to catch the opportunities at tops.
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Sources for market trend indicators include:
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