The Nature of Market Tops, Part 2

The Nature of Market Tops, Part 2

Going back to June, 2015, in truth the markets had been weakening long before June. In August 2014 (almost a year earlier), the adv/dec line had made a double top (stopped making new highs) but the momentum indicators (momentum is a leading indicator) were showing serious weakness. Both intermediate and long term momentum had put in much lower tops on the second top made by the adv/dec line in late August. The market was preparing itself for its October swoon in 2014. After the market sold off in October, it put in a v shaped bottom and shot right back up again. But the ensuing market that followed was a different market. Sure the indexes that everybody watches were making new highs. But the underlying market was much weaker. Long term mom barely inched up past the lows made in October and looked anemic. Intermediate term momentum was capped at the 50 percent level after pushing the 100 percent level the previous summer. The distribution top carried on through the winter and spring of 2015. Risk was at a elevated level at this time with little reward in the offing. I saw all of this and turned a blind eye to it. I didn’t want to believe it so I stopped looking at it. Such is the importance of psychology when investing in the markets.

Permit me a few observations...

I don't trust indexes like the SP500 and the Dow Industrials.  I feel they can be too easily manipulated and yet they are the indexes the mindless media focus on or maybe the indexes they are told to focus on...who knows.

The adv dec line of the NYSE is of pivotal importance. It shows how the whole market of the NYSE is performing. By applying a few simple moving averages to it and generating some momentum indicators from those moving averages you can gain genuine insight into the state and health of the stock market.

The temptation is to try to predict the future of the market from these indicators. I feel that is a mistake. Ive already droned on about the fallacy of trying to predict the market (the ego, remember). I see it as a risk management tool. Something to help you weigh the risk reward condition of the current market place.

The object of applying moving averages to the advance decline line and generating momentum indicators from those moving averages is to filter out the noise of the market. This will leave you with the meaningful messages and signals of the underlying data. Pay attention to the signals, not the noise.