Using the same vertical count method we used on the Dow Industrials to calculate a potential bearish price objective of 10,250, we've got the calculator humming and the current bearish price objective for the SPX comes in around 1,300. Hmmm, that's just low enough to undercut the October 18th lows of 1,305 and possibly trigger a bunch of sell programs and get some cheap stock from panic selling. We've now got two potential bearish price objectives we can write down and stick on our monitors, not to mention, set some alert level at. Again, we're not stepping in and buying everything at those levels. We're on the alert for a potential reversal! Look at the bullish percents below and ascertain for yourself if this market is starting to get a little oversold? There are a lot of brokers right now that may be hiding under their desks or are taking off for a long weekend. For those that are hard at work and setting up potential trades and looking after their clients, they're worth every dime they're paid. For those traders that are hard at work, following their plan and constantly assessing risk, don't forget to pay yourself by taking profits when the rally comes.
Bullish Percent Updates
The following are Monday's "bullish percent" readings. This is our second attempt to put in front of traders a new perspective of looking at indexes and the markets. This information is not to be used by itself, but is a tool we feel can give traders an institutional perspective on assessing risk and general strength/weakness in the market and specific sectors we trade everyday.
Overview Traders can compare this Monday's "Bullish Percent" to last week "Bullish Percent" in order to get a feel for what sectors are on the move. The Biomedics/Genetics, Internet, Software, and Telephone sectors continued to fall this week, but not as precipitously as last week. The Biomedics/Genetics fell from 20% to 18%. Internets fell from 22% to 16%. The Software sector fell from 28% to 26% and the Telephones fell from 28% to 24%. Traders should continue to monitor the above referenced sectors, as they may be key to a NASADAQ year-end rally. We'd like to point out that a lot of sectors are shifting to the "Oversold" part of our grid. Listed below is last weeks sector "bullish percent" that will let traders compare what has happened in the past week.
November 14th Overview The Biomedics/Genetics, Internet, Software, and Telephones sectors all fell precipitously from the previous week. The Biomedics/Genetics fell from 58% to 20%. Internets fell from 40% to 22%. The Software sector fell from 42% to 28% and the Telephones fell from 44% to 28%. Traders should be alert and watch the above referenced sectors for further breakdowns and potential reversals.
Understanding risk is key
Ask any football coach what he perceives to be most important variable to winning a game and he will say "maintaining favorable field position." In order to avoid severe losses, and understand risk, traders need to know where they stand on the field before placing trades. They also need to understand the principles of risk in order to optimize their rewards. Of the many market indicators traders have at their disposal, we like the "Bullish Percent" as a way to determine our "field position."
The Bullish Percent is a quantitative indicator that helps guide us and gives traders and investors an idea as to the kinds of "play calls" they need to be looking for. In a football game there is a time to be playing offense and a time to be playing defense. Depending on who's on the field, "play calls" vary depending on what goal line you're closest too.
Calculating the bullish percent?
When calculating the Bullish Percent you divide the number of stocks trading on a Supply/demand buy signals (buy signals are bullish) by the total number of stocks listed in the sector or index. The highest level achievable is 100%, and the lowest level is 0%. If we are monitoring a 500 stock index, and 200 of the stocks have recently generated a "buy signal", we can quickly calculate a 40% bullish reading (200/500 = 40%). We would argue that an index that is trading near 100% is inherently more "risky" than a sector trading near 0% for a bullish trader. The opposite would be true for a bearish trader.
The Playing field
We think the best seats at a football game are near the 50-yard line, and that's where we will be sitting when looking at the playing field. The left endzone is titled "Oversold", mid-field "Normal", and the right endzone is titled "Overbought". The terms "Oversold" and "Overbought" are quantitative and not arbitrary terms like we hear in the media. The important parts (field position) of the grid (football field) start near 30% and 70%. Touchdowns are not necessarily scored in the end zones, but once the team (index/sector) reaches the 30% and the 70% levels, they score. Levels above the 70% are generally considered overbought and levels below 30% are considered oversold. Next time an analyst makes an "overbought" or "oversold" call on a sector, check the bullish % just to make sure.
The best "bull alert" signals come when the Bullish Percent goes below 30% and then reverses up (must reverse 6%) into a column of X's (demand). The best profit taking signals come when the indicator moves above 70% and then reverses below 70% into a column of O's (supply) There are six signals, or degrees of risk associated with this indicator:
Bull Alert: Characterized by the Bullish Percent falling to 30% or below and then reversing up into a column of X's. The traffic light turns green. Looking for stocks that are breaking downward trending, or horizontal resistance.
Bull Confirmed: The strongest of market conditions. Characterized by a column of X's exceeding a previous column of X's. The traffic light is green. Looking for stocks that are breaking out of bases, or stocks that have pulled back to support after breaking a trend of resistance.
Bull Correction: The bull market is taking a breather though it should resume shortly. The traffic light is yellow. Looking for stocks that have pulled back to a level of support or breaking out of consolidation.
Bear Alert: Characterized by a Bullish Percent falling from above 70% to below. Profits should be taken or positions hedged. The traffic light turned red. Looking to short stocks that have underperform the recent "sector bull market", or stocks that previously broke a big level of support on volume, then rallied on weak volume.
Bear Confirmed: The weakest of markets conditions. Characterized by a column of O's exceeding a previous column of O's. Traffic light is red. Shorting breakdowns or rallies to resistance, with stops close by.
Bear Correction: The bear market is taking a breather. Trading rallies could be seen, but the bear market will likely resume. The traffic light is flashing red... look both ways carefully before crossing the intersection. Looking both ways is key. Most of the damage is done, but there may still be some casualties. Be quick to cover shorts that move against you, as they may be leaders in a new secular bull market. Remember, when evaluating any particular signal (or risk level); be sure to take into consideration the field position.
Sector Bullish Percents
Using this concept, traders should monitor bullish percent levels for the groups in which they trade. The percent of stocks on buy signals in each sector is plotted on a grid from 0% to 100%. Again, the best "bullish alerts" come when a sector reveres into a column of X's from below 30% and the best "bear alerts" come when a sector reveres into O's from above 70%. The same six signals, or risk levels apply.
SUPPLY/DEMAND CHART FOR "XYZ" STOCK
What generates a "buy signal" in a stock? When a column of X's (demand) exceeds a previous column of X's, a "buy signal" is generated. Examples of "buy signals" are noted above, circled in green. What generates a "sell signal"? When a column of O's (supply) exceeds a previous column of O's. The five sell signals were noted when a column of O's exceeded a previous column of O's (red O's).
Understanding everything on a chart
Now that we explained X's and O's on a specific stock and its supply/demand chart, we'll take a minute to explain how "time" and "trend" are accounted for. Reference to time; the numbers (5,6,7,8,9) found on our chart refers to the beginning of each month that a particular price level was achieved. For example the first X or O in May would be replaced with a "5", June is marked "6" etc. The months October through December are noted A, B, and C, respectively. Traders should note the "*". These are used to represent changes in trend. Until this "trend line" is broken, its progression should be monitored and understood.
Bullish Percent for the Sector - 2% scale.
Trade like an Institution
The above chart is a "bullish percent" chart. It is NOT a chart of a stock. It is a quantitative measure of supply/demand "buy signals" that has been charted on a 2% scale. During August, XYZ (the STOCK) was in a column of X's and gave a "buy signal" at the 118 level, while the SECTOR that XYZ is a component of(immediately above) was in a column of O's. This told us XYZ was a leading stock in a sector that was in a "bull correction" phase. When September (blue 9) arrived XYZ's fortunes changed and reverted back into a column of O's (a sign of weakening) and the Computer Sector had reversed into a column of X's (a sign of strengthening). If we correctly identified XYZ as a "leading indicator" what would we perhaps expect from the group?
Institutional market makers are constantly assessing risk at their trading desks. Traders that want to think like an institution view the equity markets purely on a risk/reward basis and the bullish percent is a great tool to understand this risk. As traders, we must realize that a market maker has to provide liquidity regardless of market direction. If you put yourself in their shoes, you'll probably see that a market makers biggest challenge is managing risk/reward solely on a supply/demand relationship. If we as traders (craftsperson) can use this tool along with our bar charts, MACD, etc. we can get a better feel of what institutional traders, or institutions may be doing. If we're monitoring "big money" and doing what they're doing (markedly different than what they may be saying) we stand better odds of profiting.
Print this out!
Print this information out and keep it accessible. We will be using the bullish percent in future discussions and intra-day updates.