Approximately 3 out of 4 stocks follow the trend of the market (the major indexes such as the S&P 500, NASDAQ, NYSE, etc..). Therefore, if you are able to accurately determine the State of the Market, you have a much better chance of capturing and capitalizing on broader trends.
Today we’re going to discuss how we size up the “State of the Market” and how you can do it too. We’re going to look at everything that is on the surface by way of the major indexes and then everything that is “Under the Hood” which are those elements that drive the major indexes.
Our Core Market Beliefs
One of our core market beliefs is that everything that affects markets manifests itself on the charts by way of price and volume action. We also believe in trend following which means that we aren’t attempting to predict which way the market is going to turn next, but rather investigate the various signs and signals it presents to us, size them up as bullish or bearish, and then see which way the scale is tipping. No one element outweighs everything and it is extremely rare to see ALL elements as either bullish or bearish.
Analyzing the Major Indexes
In my personal trading, I’ll typically analyze the Nasdaq, S&P 500, and the NYSE. I’ll analyze these three because the vast majority of the stocks I’m interested in happen to trade on these three. What is important isn’t necessarily including these 3 or some other 3, but analyzing them consistently. Consistency is one of the true keys that make trend following work because it is by way of consistency that we can pick up on the subtle clues the market gives us that something may be changing. Analyzing the Nasdaq one week, the Dow the next, and the Russell after that, doesn’t lend to the consistency required to see the subtleties as they unfold.
What we’re looking for
Each index and each timeframe tells its own story. We included the table below to break down the various elements we look for by timeframe.
Daily |
Weekly |
Monthly |
|
Distribution Days |
Distribution weeks |
Distribution Months |
|
Accumulation Days |
Accumulation weeks |
Accumulation Months |
|
Follow through Days |
X |
X |
|
Length of rally/correction |
Length of rally/correction |
X |
|
Status (uptrend, under pressure, correction) |
Status (uptrend, under pressure, correction) |
X |
|
Action around moving averages |
Action around moving averages |
Action around moving averages |
|
Action around trend lines |
Action around trend lines |
Action around trend lines |
|
Support/resistance levels |
Support/resistance levels |
Support/resistance levels |
|
Larger price patterns |
Larger price patterns |
Larger price patterns |
It is important to analyze each index and each time frame on each index individually as they will each tell their own story. In a strong bull market, for example, it’s possible to see distribution days pile up, multiple sharp
In a strong bull market, for example, it’s possible to see distribution days pile up, multiple sharp pull backs, and other action that is considered bearish. When we look at the weekly and monthly charts, it’s often possible to see quite a different story. What appears wide and loose or ready to fall off a cliff on a daily chart may not look so bad on a weekly or monthly chart. It’s possible that the market is simply testing long-term support levels. What looks like a sell on
What looks like a sell on one time frame may be a buy on another. The only way to know this and take advantage of it is by studying each time frame. Even if you trade using a different time frame, it’s important to know what the other time frames look like so we can be ready for the road ahead. The extra effort will be well worth it.
A Peak “Under the Hood”
What happens on the indexes is driven by what is happening “Under the Hood” and what is “Under the Hood” can mean slightly different things to different types of traders. On ChartYourTrade we’re interested in the following:
- New Highs vs New Lows made on the Nasdaq and NYSE
- Behavior of leading growth stocks (for how we find leading growth stocks, click here)
- Behavior of stocks setting up (those presented in our Elite Stock Setups)
Having insight into these three elements provides insight into what is driving the moves on the indexes as well as how conducive our trading methodology is to the current market environment. It helps us determine if our portfolios should be stepping on the gas or hitting the brake. There is no one strategy that works in every market. We can’t be long in a bear market and expect to make big money. However, by analyzing these elements that are “Under the Hood” in conjunction with our analysis of the major indexes, we’re able to determine when we should be trading and when we should be backing away.
New Highs vs New Lows
We look at the number of New Highs vs New Lows being made on the NYSE and Nasdaq to give us a flavor of the intensity of strength or weakness we’re seeing in the market. In a bull market, it would be difficult for the indexes to continuously make higher highs without the stocks within them also making higher highs. At turning points we’ll often see the action here diverge from the action on the indexes, thus providing an early warning of a change in direction.
Below is a sample of how we like to track and archive these numbers. Our stock scanner and analysis app ChartYourTrade MRI tracks and archives these numbers for us daily. We’re able to easily put these numbers into Excel and create the charts below. This helps us monitor the expansion and contraction of new highs vs new lows.
Behavior of Leading Growth Stocks
These are the stocks we’re actively trading and therefore it behooves us to know how they are performing as a group. Every week we monitor the Universe for the following:
- Overall Advance/Decline of the Universe
- Expansion/Contraction of the Universe (were stocks added or removed from the list)
- Sector rotation within the Universe
- Leading/Lagging Sectors within the Universe
- Leading stocks from within Leading Sectors
- Leading stocks within expanding sectors
This may sound a bit overwhelming and a lot to monitor at first but remember that since we have already built our Universe List, the ground work has already been done. Once you have your routine down and are doing it consistently, it’ll become less and less time consuming. Knowing what is happening from within the our Universe in essential to knowing how we should be trading and plays a key role in shaping our perception of the market.
Behavior of stocks setting up
Similar to understanding the overall performance of stocks in our Universe, we also want to know how the market is treating stocks that are setting up near a pivot or entry point. Are these stocks breaking out, meandering around their pivots, having false breakouts, or breaking down before even getting off the runway? How the market is treating stocks that are setting up will also tell us if we should be actively participating or backing away.
When analyzing the lists as a whole, we look at the following:
- Overall advance/decline of the lists
- Overall size of the Ready List (expansion/contraction)
- Types of setups (primary bases vs secondary setups, early stage vs late stage bases)
- Quality of setups in primary bases (judged by the overall score from the Stock Evaluation Guide)
- Number of stocks per sector that are setting up
- Ratio of stocks setting up to number of stocks in that sector on the Universe list
- 3 biggest weekly gainers and decliners
Summary
After analyzing everything that is on the surface (the major indexes) across multiple time frames, as well as everything that is driving those indexes and our methodology by way of what is “Under the Hood”, we are able to determine the overall current State of the Market.
