In each night's Index Trader Wrap at OptionInvestor.com, I try and update some of the indexes we talk about and their associated bullish % charts. These bullish % charts are to help traders and investors understand "risk" in a market and have that risk be understood in a QUANTITATIVE manor.
For some, the X's and O's that a point and figure chart use seems so absurd that the simplistic approach of monitoring supply and demand seems to lack merit with some. However, when one thinks about "percentages" and a scale of 0-100% and asks the question... "If I'm at 70% what's my downside to O% and what's my upside to 100%" the trader/investor begins to get a sense of "field position" or risk/reward.
It only takes a couple of "cycles" and some terrible trades to better understand just how the bullish % charts really seem to be a great barometer for risk and "who has got that risk," when related to bulls and bears. Sure, there are individual stocks that will trade against the MARKET risk, but for the most part if MARKET risk levels are low, then that would "mean" that most stocks tend to have less bullish risk but GREATER risk for bearish traders.
In past commentary and in the Bailey's Basics section of both the premierinvestor.net and OptionInvestor.com sites, I've written updates similar to "Understanding risk is key."
As many bears have witnessed and even bulls, in early October (red A on a point/figure chart) the RISK for BEARS was HIGH, and bulls were simply awaiting some type of reversal up in the Bullish % charts to show internal repair taking place.
Many consider the S&P 500 Index (SPX.X) 932 -0.15% a fair benchmark for the "market." The 500 stocks represent multiple sectors or industries. By simply tabulating the number of stocks currently having a point and figure (supply/demand) buy signal associated with the chart, we can begin QUANTITATIVELY understanding how bullish or bearish a market is.
If there has ever been proof that a successful strategy of investing is to "buy high and sell low" then the bullish % charts perhaps drive home that point.
S&P 500 Bullish % ($BPSPX) - 2% box
I've tried to "color" code the recent "cycles" of the bullish % chart on the right side of the chart. Recently, in early October (just after red A) the bullish % chart reversed up at least 3- boxes, or 6% to a "bull alert" status. As time progressed, bullishness built (blue turns to pink after 3-box reversal higher). Yesterday's action had the current X column (demand) EXCEEDING the previous column of X (demand) and that generates somewhat of a "buy signal" on the bullish % chart. This creates the "bull confirmed" cycle as more stocks now show a point and figure buy signal on their charts than in late August (after red 8, but just before a reversal lower at red 9). Just like a roller coaster, the market internals, as depicted by the bullish % will go through "bullish" and "bearish" cycles.
Now, as we get to broader indices like the S&P 500, you can imagine that it would take more EXTREME levels of bullishness to get more and more stocks generating "buy signals." It's analogous to trying to push a BIG barrel up a hill as opposed to kicking a smaller can, like the NASDAQ-100, which only has 100 stocks comprising it, up an identical sized hill. As such, it can be more difficult for a broader index like the S&P 500, or even the NASDAQ Composite and NYSE Composite, which have about 3,000 stocks levels above 70%, which are deemed more "overbought."
But take a BIG barrel, or even a small can and push or kick it down a hill for a high level and you can sense the impact that "gravity" has on things. While it can be tough to push a barrel up a hill, it's less difficult to push it down the hill.
Now.... I'm going to try something different today than I've done before to try and help traders and investors understand how the S&P 500 Index has traded over time. Instead of using a conventional box size on the actual point and figure chart of the S&P 500 (conventional scale is $5), lets remove some noise from the chart and increase the box size to $20. To make a "tie" between the bullish % and "risk" I can make reference to relative highs on the above bullish % chart and "test" to see if the SPX has ever seen any type of price change from those same periods. In essence, as the MARKET ever tried to adjust itself to compensate for higher or lower levels of risk?
S&P 500 Index Chart (SPX.X) - $20 box
By changing box scale, it's kind of like looking at the earth from outer space isn't it? One can imagine what a mistake it has been to be OVERLY short when the bullish % chart has been below 30% and what a mistake it has been to be OVERLY long when the bullish % gets above 70%.
The purpose of this intra-day article when the markets are very calm and not that active is to give investors and traders the perception of risk for bulls right now, but also the observations that there is till some upside to be had and that BEARS don't need to be overly aggressive and putting on a bunch of bearish trades with the thinking that the bullish % will soon reverse lower. Look at the bullish % benchmarks on the first chart and understand how much time there has been in the past to actually get short. Also look at past levels of growing bullishness to understand there may still be some 20-40 points of further upside. However, does it make sense of a bull to all of a sudden now begin loading up there account in bullish trades?
On a risk/reward basis and using the bigger picture $20 box, reward is $40, while risk to support is $140.
For OptionInvestor.com subscribers that will read this weekend's "Ask the Analyst" column, we'll use this update also when talking about certain stocks to trade as it relates to "field position" and the bullish % charts.