Current Market Environment

Current Market Environment

The terrain of the current market environment will play such a dominating role in your investing results that it is impossible not to consider its impact both on yourself and on every other participant in the market. Over the years I have developed an approach to keeping tabs on the market by focusing on the market breadth of the NYSE and the NASDAQ. For those of you who do not know, everyday individual stocks go up while others go down. At the end of the day these figures are tabulated and published in various financial newspapers and websites. I use the weekly figures in Barrons to get my figures as they publish the common stock data for the NYSE which is the one you want to focus on.

You can create a cumulative running total of the differential of these daily advances and declines and log them in a spreadsheet. This running total has a familiar name. The Cumulative Advance Decline Line. I take this running total and apply a few moving averages to it to smooth out the noise of the indicator. This helps you observe the underlying trend of the market. I then subtract the longer moving averages from the faster ones which produces trend deviation indicators (a form of a momentum indicator). I track the momentum of the underlying market on a short, intermediate and long term basis.

I have found this information invaluable over the years but it took me a long time to first develop these tools and then learn how to use them. Finally I had to overcome my own thinking when they told me things about the market that I didn’t want to hear.

I have learned that the nature of tops is one of slow deterioration as the informed money gradually distributes their holdings to the masses while the major indexes will continue to go up. Meanwhile the underlying market is giving way and going down.

Bottoms come about from a collapsing phase followed by a bear market bounce and then a gradual deterioration as people come to realize that there has been a change in the psychological makeup of the market place.

During weakening tops intermediate term momentum will begin to flag and top out at a lower level than it did last time. At bottoms there will be divergences when comparing momentum with the Advance Decline Line itself.

These indicators also serve as excellent sentiment indicators. I feel confident when they start to speak to me as I’m getting information directly from the market itself. No opinions are needed. Keep an eye on the media and how they sound as they will add some colour to your analysis. Remember during market extremes be contrary or as Albert Peter Pacelli once said, ‘Demand Supply and Supply Demand.’

One more thing before I go. I use these indicators in an attempt to manage my risk in the market. I do not use them to forecast or make predictions. Predicting the future for me anyway is a dangerous activity because part of your ego is going to be attached to your prediction. It's been my experience to try to keep my ego out of the investing process. You can manage your risk by lightening up on your overbought positions when the underlying market is slowly deteriorating or sell some positions outright. I'm still working on doing this as I am a fairly inflexible long term investor who likes to hold his positions for a long time. So like everybody else I am learning all of this stuff as I go along.

For those of you who don't want to bother with keeping your own statistics on the market I can recommend  the following link...

http://stockcharts.com/h-sc/ui?s=$NYA&p=D&yr=3&mn=0&dy=0&id=p83733137120

The bottom part of the chart is the McClellan Summation Index for the NYSE. An intermediate term momentum indicator for the market breadth. Both the direction and the level of the indicator are equally important. Nothing ever really bad happens to the market when the McClellan Summation Index is above zero.