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A Key Volume Indicator

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The rain on the parade of the recent earnings-driven rebound remains the likelihood for a housing recovery. Anything like today's dismal news on housing which causes selling in the financial sector especially impacts the S&P 500 Index (SPX) and the Dow 30 (INDU) but spills over into everything to some degree. Today INDU was off 2.4% and SPX was down 2.3%; this versus the Nasdaq Composite (COMP), which at least held under a 2% decline (-1.97%).

TECHNICALLY, there are THREE key indicators, that I rely on to suggest that a reversal in the dominant down trend is sustainable and that counter-trend advance is going to run for a while; e.g., a rebound that achieves a 50% retracement of a prior downswing in the market. The mid-March to early-June rally in COMP retraced a bit more than 50% of the late-October to mid-March decline. SPX also retraced a little over 50% of its prior decline.

While the aforementioned March-June rebound did not turn the MAJOR trend up and weakness followed the one-half retracement, the rally into mid-May (SPX) or early-June (COMP) was very worthwhile from a trading standpoint. It was my kind or rally: not of 2-3 days or 2-3 weeks duration but of the 2-3 month variety. Not that I wouldn't like to be in on EVERY 2-3 week advance or decline that fell or rose 100-150 S&P points and an equivalent point swing in the Nasdaq!

The following 3 indicators suggest that a significant bottom is in place when ALL 'line up' at the highlighted low readings on the two charts that I'll present. It is often the case that one indicator 'signal' follows the other and are not simultaneous, but at least occur in a similar time frame.

The 3 TECHNICAL indicators that I've found need to be in synch for a sustained turnaround in a dominant down trend are:
1.) Sentiment extremes; i.e., traders get extremely bullish or bearish.
2.) 'Overbought'/'Oversold' extremes are seen, as measured by the Relative Strength Index (RSI) indicator.
3.) The market bottoms in terms of "weight", as suggested by 10-day averages of total NYSE and Nasdaq UP Volume

This last indicator, that of the 10-day NYSE or Nasdaq average of ADVANCING volume will get a more detailed explanation after the charts as I don't discuss this one all that much AND it's useful in finding BOTTOMS ONLY.

Indicators 1 and 2 above are ones that I've discussed many times in my (weekend) Index Trader and (Thursday) Trader's Corner columns. That is, traders need to get quite bearish in their outlook (sentiment), as measured by my 'CPRATIO' (daily equities call to put volume ratio); AND, there should be an 'oversold' extreme in the 13-day RSI indicator.

Along with the first two indicator extremes, a 10-day moving average of daily total Nasdaq and NYSE Advancing (Up) Volume should contract to certain lows and then turn UP.

What was missing in this last upturn, was a contraction of NASDAQ volume to a level that has usually been associated with major turning points in the Nasdaq market and the overall market. Maybe this won't happen THIS TIME of course, but it's been highly unusual in the past to see a major market low where investors were CONTINUING to do substantial accumulation of one market sector; tech stocks in this case. It could be a paradigm shift or it could just be that we won't see a SUSTAINED market rally until the Nasdaq bottoms in terms of the VOLUME indicator I'll describe.

At the March low in the Nasdaq Composite as seen above, first the RSI registered a fully oversold extreme (1), then shortly thereafter, trader sentiment got extremely bearish (2) and lastly, Nasdaq 10-day UP volume dipped to below 300 million shares and then turned UP from there (3). All three indicators were then in synch and a major rally followed.

On this recent low (see above-right), which presented a decent short-term trade in calls and short puts, while the jury is still out on whether a SUSTAINED rebound is yet possible, total Nasdaq UP volume did NOT contract to the area where it did in March and on most prior rallies occurring after major declines. On this basis, it was not surprising to see the rally run into trouble today.

The next chart presenting highlights of the 3 indicators and does so in conjunction with the S&P 500 Index (SPX) chart, and presents the 10-day moving average of daily NYSE Advancing volume. What happened over many weeks recently is that NYSE UP volume just flattened out, as buyers stepped away, particularly from the financial stocks. This is seen in the UP volume average dipping below 600 million shares and staying there, drifting sideways. The 10-day moving average did finally turn up recently from below the key level green line just ahead of the recent rally.

All 3 indicators recently had the kinds of lows (when occurring in a similar time frame) and subsequent upturns associated with a substantial bottom. The pattern doesn't mean that prices won't drift sideways to lower into the fall seasonal low timeframe until the buy signal pattern repeats itself. Bearish sentiment in particular may see a LOWER extreme before a sustained rally develops.

ADVANCING VOLUME INDICATOR:
Certain measures of trading volume often precedes price trend reversals or turnarounds. For example, before a market gets to or near a price area that will be perceived as offering "value", especially a market that is in transition, there will be a contraction of trading activity (volume) to a similar and reoccurring level and this occurrence will tend to precede the most substantial and sustained market rallies.

The most significant volume figure is Up or advancing volume, which is a count of all shares bought on upticks, or at a price higher than the preceding transaction. Up volume is a true test of buying interest as it reflects willingness to 'pay up' for stocks. Shown above, as the first of 3 indicators, is a line measuring the 10-day moving average of advancing volume for Nasdaq and on the second chart, a line on the following chart a line measuring the 10-day moving average of advancing volume for the New York Stock Exchange (NYSE).

InIn the period shown and in prior years not shown, when the 10-day moving average of Nasdaq up volume has shrunk to between 300 to 500 million shares or lower and then turned up, market upturns have followed or coincided with it. For any given 2-3 period typically, there will tend to be declines in this 10-day average up volume number to the same approximate area, before the average starts expanding again. This 'base' line tends to be quite consistent but the number can vary from one market cycle to another. The specific levels will not be the same in every market cycle or in a bull market versus a bear trend.

Particular levels of Declining volume on a 10-day average basis, is not especially predictive for market tops, nor does the market peak as reliably at a particular level of Advancing volume, such as is the case for market bottoms. At tops, when the 10-day advancing volume line turns down, whether from an area where it has peaked before, the downward trend of the line can be a SECONDARY indication that prices will continue lower as it suggests that an intermediate down trend is underway. However, I use the Up Volume indicator as one of the predictors for bottoms ONLY.

QUESTIONS/COMMENTS:
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GOOD TRADING SUCCESS!
 

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