Using Key Indicators and Tools to Understand Market Decision Points By, D.R. Barton, Jr.

Barton TT1Today’s article was going to be a cool introduction to a series on psychological biases that investors and traders need to keep “front of mind”, especially in today’s evolving markets. However, with the U.S. debt ceiling rhetoric ringing in our ears and both sides of the political spectrum milking the drama for all it’s worth, I was carried in my memory to Cherry Grove — the northernmost beach in South Carolina.

Why did my mind leap there? Because in early August of 2011, I was looking out of the screen porch in our rental house and watching the waves of the Atlantic Ocean when the Standard & Poors rating agency downgraded U.S. debt from AAA to AA+.

Many (most?) analysts believe that the debt ceiling negotiation is just stagecraft—both sides posturing trying to get the best deal for their political allies. And yet, the inability of Congress and the White House to get a deal completed makes this S&P ratings agency’s quote in the Wall Street Journal article from August 6, 2011, seem quite important again.

“S&P said the downgrade “reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” It also blamed the weakened “effectiveness, stability, and predictability” of U.S. policy making and political institutions at a time when challenges are mounting.”

(The emphasis is mine.)

So, What’s an Investor or Trader to Do?

I like to turn to my tools to look at what possibilities are brewing. As I implied above, most analysts who I communicate with are viewing this 11th-hour wait for a debt ceiling deal as a negotiating tactic.

The most cited reason for the belief that the debt ceiling will be sorted out is the fact that the S&P 500 and the Nasdaq stock indexes have stayed near the top of their May ranges:

1154 DR Chart1 1

It still seems that a negotiated end to the debt ceiling craziness will be met with market cheers — and more upside.

However, one very key indication of market health that we look at in this space relatively often has been the state of broad market participation, or market breadth, during times of key market decision points. Let’s first take a look at our old friend, the cumulative Advance-Decline line.

As a refresher, cumulative breadth is a simple calculation. Each day, the New York Stock Exchange (NYSE) reports an “advance-decline” number, which is simply the number of stocks that closed higher today than yesterday, minus the number of stocks that closed lower. This number is also called by many, simply, “market breadth.” If you add those sequential daily breadth or advance-decline numbers together, you get a cumulative number.

Currently, the market breadth has been dropping, especially for the last four weeks:

1154 DR Chart2 1

Tom McClellan charted a similar breadth divergence when comparing the Nasdaq market capitalization index ETF (QQQ) versus the Equal weight index (QQEW):

1154 DR Chart3 1

Both charts tell us that the Mega Tech stocks like AAPL, MSFT, AMZN, META, NVDA and others are leading the market higher, while lesser others are not following along. This can persist for a while but it tells us that any stumble in the debt ceiling negotiations could have a stronger effect on the markets than usual.

One of the things that I love about having tools and strategies that I’ve used for years is that I can understand current events and how they might affect trading and investing decisions better. RJ Hixson does a great job helping us understand lots of tools that are available in the System Development Workshop that’s coming up in a couple of weeks. I hope to sit in for a few of the sessions and I’d be happy to answer any questions you might have if you still haven’t made a final decision on whether you’ll be attending.

I’d love to hear what tools and tactics you use to help you make good decisions in difficult markets. Let me know! Relay them to me and any other thoughts or comments you have. Send them to me using drbarton “at” vantharp.com

Great Trading and God bless you,

D.R. Barton, Jr.

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