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Technical Analysis of Breadth and Volatility Measures

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Some technicians are just flat-out going to disagree with the premise of this article. I'm proposing that technical analysis tools work with breadth and volatility measures.

Note: Charts were chosen with respect to the points being discussed, and do not represent current prices.

Annotated Fifteen Minute Chart of the Wilshire 5000:


Annotated 15-Minute Chart of the VIX:


Just as the Wilshire 5000 had done, the trending-higher VIX was bouncing from a moving average. Coincidence, you say? Let's look at that same chart using another tool of technical analysis, the regression channel.

Annotated 15-Minute Chart of the VIX:


Why does it seem strange or a stretch, as some claim, that regular technical analysis tools might be applied to breadth or volatility measures? The great McMillan of OPTIONS AS A STRATEGIC INVESTMENT fame mentions that volatility measures of individual stocks tend to settle into a trading range. He has no trouble characterizing a volatility measure in terms of a trading range.

Going a little further out onto that limb, let's look at the advdec line using one of my favorite technical analysis tools, nested Keltner channels.

Annotated 15-Minute Chart of the Advdec Line:


On 8/08 and 8/09, indices produced one of each of the moves that the advdec line's Keltner setup suggested as possibilities.

Annotated 15-Minute Chart of the SPX:


Although my study of the advdec line on nested Keltner charts has just begun, the support and resistance levels set out by nested Keltner channels sometimes have eerily correct resonances with movements in the advdec line. While equity prices do not always move in lockstep with the advdec line, this has proven to be a helpful tool in recent weeks. On August 1 and 2, the advdec line was showing Keltner-style bearish divergence, hinting at weakness to come. That weakness showed up on the morning of August 3. After another attempt to rise, in which the SPX retested its recent high, the advdec line fell back and SPX prices began tumbling, too. The correspondence was not exact, but did prove helpful in gauging potential market action.

Annotated 15-Minute Chart of the Advdec Line:


While these charts can provide only anecdotal evidence, my years of watching breadth and volatility indicators using standard tools of technical analysis provides enough evidence to convince me. I see no difficulty in believing that technical analysis tools might provide useful when studying volatility or breadth indicators so long as I believe that market participants might be reacting to levels considered high or low by actions that might change these measurements. In a simple example, if the advdec line were to drop to a level considered extreme, some contrarians might begin nibbling on equities, thereby changing the advdec line and eventually turning it higher again if the buying was strong enough.

Go wild. Snap a Fib bracket on the advdec line or a Donchian channel on the VIX. See if they help you. I bet they will, but just don't tell your technician friends who insist there's no possible correlation between these indicators and standard technical analysis tools.
 

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