The internals for the NASDAQ-100 showed weakness once again on Friday as one of our key indicators for assessing market risk and strength reversed lower. As of Friday's close, just 35% of the stocks that comprise the NASDAQ-100 had their charts showing a point and figure buy signal and this action should have traders only trading bullish in stocks that are close to support levels and shorting those stocks that are breaking down from a consolidation level or recently rallying to a level of resistance.
NASDAQ-100 Bullish Percent - 2% scale
Bullish traders wanted to see the NASDAQ-100 bullish percent chart trade at 52% and get this indicator back into "bull confirmed" status, but that didn't happen. The defensive team should be back on the field once again. This indicator can get whipped around on a daily basis, especially as it gets closer to an overbought or oversold level.
Understanding and interpreting the bullish percent takes time to get used to. If we overlay some of the key inflection points of the bullish percent chart on the chart of the QQQ it then helps us look at the market much differently than most are used to. In fact, it helps the trader look at the market from the institutional trader level. Constantly understanding levels as well as index strength/weakness and risk/reward.
NASDAQ-100 Index Tracking stock - last 4 months
Just remember that the numbers that occur on the bullish percent chart (red 3, 4, 5, 6, 7) are chart entries that were made at the beginning of a month. March is equal to 3, April is 4 and so on. The QQQ is made up of stocks that are price weighted. Often times, just one or two stocks can greatly influence how this index trades. The bullish percent however it NOT price weighted as each stock gets only one "equally weighted vote" in the form of a buy signal or sell signal.
In our analysis of the QQQ, we've been using a "fitted" retracement bracket to help us define levels from which to trade. Four sessions ago in OptionInvestor.com's hot list, we thought the QQQ would be a favorable risk/reward trade for a bearish trader looking to short this index. Not only did the trader have good correlation from the retracement bracket, but if we were thinking in terms of bullish percent and what it means about sector risk and sector strength, we would have noticed that the last two reading of 50% found the latest reading coming when the QQQ was actually trading near $46 instead of a previous QQQ value near $48.75.
What this action told me is that there must have been a couple of stocks in the QQQ that account for a large weighting in the index that were beginning to under-perform on the upside and were beginning to adversely impact the outward appearance of the QQQ.
While the QQQ is sitting right on retracement support at $41.24, this would be a good level to be looking long as it relates to the technicals of the bar chart. One of the main reasons I point this out is some of the divergence we are seeing in the bullish percent currently on this pullback. Notice the bullish percent reading currently is at 35%, while the last pullback to current levels was 26%. While the bullish percent gives hint that a lot of risk has been reduced in this index, it also spells of some strength and perhaps an attractive entry level for certain stocks in the group.
It DOESN'T mean that current levels are attractive for ALL STOCKS in this index! As long as a trader goes into a trade with the mind set that "I'm seeing some divergence in the bullish percent chart as it relates to recent past readings and am going to honor a stop should the QQQ break below the $41.00 level, then I can afford to selectively look long in here."
Earlier today on OptionInvestor.com I felt that shares of Microsoft (NASDAQ:MSFT) was such a stock to be looking long at the $66 level. Here's the largest weighted stock in the QQQ that has recently "underperformed" on the upside, but is trading right on top of what should be a good support level at $65. If I were to correlate a breakdown in the QQQ below its retracement level of $41.24 with that of MSFT at $65, then I have a firm stop that I can trade confidently from. At the same time, if the divergence from the bullish percent chart holds and we get a reversal back into a column of X's, I'm probably going to be trading long in a longer-term strong stock like MSFT, that was purchased near support in an index that is on the verge of recovering.