oftwominds-Charles Hugh Smith

Forgotten Indicators: Is the Stock Market About to Turn Up?
February 5, 2009

Frequent contributor Harun I. shares an analysis of three largely forgotten indicators which may be suggesting the stock market is building a base for a Bear Market rally.
Please go to www.oftwominds.com/blogfeb09/indicators02-09.html to view the 3 charts.

The first chart is of the NYSE Cumulative New Highs/New Lows. This is a cumulative measure of the difference of stock making new high and those making new lows. This indicator is below its 52-week SMA and is still declining as of 02/02/09.

In 1998 this indicator stopped making new highs as the market indices (DJIA, SP 500, NYSE) also peaked. The divergence occurred when the indices bottomed in mid 1998 and rallied to new highs. The DJIA and NYSE peaked in 1999, the SP 500 in 2000. These advances occurred under market conditions of declining breadth. Issues making new lows began to out weigh those making new highs. This indicator slid below its 52- week SMA mid-1998 and remain there in a decline until 4th quarter 2000.

Note that while market indices were in a primary level correction, more discretely, the trend in stocks making new high began to overtake those making new lows late 2000, continuing until indices bottomed a second time in 2003.

Currently new lows continue to outweigh new highs.

The second chart, which is probably more well known is the NYSE Advance/Decline Line. This differs from Cum NH-NL's in that "advancing/ declining" does not necessarily denote a new high/new low.

Again note the behavior throughout the primary correction that began 1999-2000. Then observe current activity. The test of the mid-2008 low in the 4th quarter did not yield a new low and the indicator rallied above the 52-week SMA into the new year. Even with the down turn it remains above its 52-week SMA, should this state remain a divergence between price and Cum NH-NL will exist. It is divergences which often warn of discreet changes in market structure (participant behavior).

The NYSE Cumulative Volume Index (CVI). It is mostly coincident. Currently it is below its 52-week SMA and starting to decline after a bounce in late 2008. It is divergent with the A/D Line.

While we have to be careful not to take one piece of data and torture it until it says what we wish, we must understand that divergences must be resolved. During the first primary correction of 1999-2003, the decline in nominal price, Cum NH-NL and CVI was not confirmed by the A/D line. The resolution of this divergence was to the up-side.

What will happen next is unknowable and not the purpose of this missive. As an exchange of ideas and information, it may be useful for the trader/investor to study market breadth. The greatest strength in these indicators is to be found when they are confirming and diverging. The AD Line above its 52-week SMA and failing to decline significantly, in my opinion, bears watching.

Thank you, Harun, for calling our attention to these divergences.

Here is an essay Harun wrote last year which remains highly relevant: The Principles of Trading Also Apply to Life. NOTE: As I have house guests for a week, I will be hard-pressed to reply to email; my apologies to all correspondents.

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