When you are unsure if the market is breaking out (to the upside), breaking down, or neutral (predominately a sideways trend), one effective way to confirm this is to study ALL the individual stocks that comprise a major index. The one that this is mostly feasible for is the Dow 30 (INDU).
A mentor I had for a few formative years on the Street of Dreams, a phenomenally successful private trader who took an interest in me, used to figure market objectives based on a 'bottoms up' approach of analyzing the Dow stocks. At that particular time, the Dow average was somewhat more dominant as a market barometer than it is today, but it's still an important benchmark for the overall market.
The Dow, along with the S&P, may lag the Nasdaq at times (sometimes it leads the Nasdaq), but the major indices are more closely correlated than not. Besides not having to study as many as 100 stocks in the S&P and Nasdaq 100 indexes, the other advantage of the Dow is that its an arithmetic average and not capitalization-weighted like the other major indexes. A one dollar move in any of the 30 stocks is equal to a dollar move in any other, in terms of affecting the Average's gain or loss. This means that you can just do a tally of how many INDU stocks are in up trend, how many have bearish charts and how many are neutral or basically going sideways and arrive at some useful conclusions.
I'll get into my evaluations and tally as of today's close, after looking at the key indexes, including the Dow.
The S&P 500 (SPX) daily chart, as seen below, has regained its bullish footing after piercing its prior closing upswing high. It has yet to clear the 50-day benchmark moving average, but piercing this level looks to be a matter of time, not IF it will or not. Evidence of a recent bottom is seen in the V-bottom formation highlighted on the chart. So far so good in terms of being in bullish options strategies, hopefully from lower levels. (I often urge traders to initiate trades at the first signs of a bottom, with close by exit points).
We would next naturally look at the Nasdaq chart, if we didn't start there. The Nasdaq Composite has similar bullish aspects to SPX, but COMP not only cleared its last upswing high but also has achieved a decisive upside penetration of its 50-day average. The same V-bottom formation is of course also apparent. Next: how about the Dow?
The Dow 30 (INDU) is running ahead of SPX in the sense that INDU has also pierced its 50-day average, which fund managers take heart from (even more so with SPX). Now, a key question for traders is how much MORE upside is there to this recent rally. Does it (the rally) have
legs? Here's where I can provide a tip on how to look at INDU from a 'bottoms up' approach, valuable also as it helps forecasts the overall market.
I keep groups of saved charts in different saved configurations. In my TradeStation charting application, they are my 'workspaces'. I run down the list of 30 stocks in alphabetical order by the ticker symbols. My first workspace is of 6 of the 30 stock charts, AA through CSCO.
My overall market evaluation here is using fairly simple evaluation criteria:
1. Bullish (+), which is that the stock has upside momentum as measured by the 50-day average, as well as evaluating the appearance of the chart pattern itself.
2. Bearish (-), with the stock trading well under its 50-day average and NOT rallying much, in line with the market.
3. Neutral in its pattern. 'Neutral' to me is that the stock is trading mostly sideways, so it's not likely to cause a big drag on the (Dow) Average. OR, the stock has a pattern that suggests the stock could get pulled along with the dominant trend; e.g., the stock also looks like it is headed toward an upside penetration of the 50-day moving average or otherwise is showing upside momentum at least on a short-term basis.
In my first grouping of 6 Dow stocks, I rate 4 as bullish (+), 1 as bearish (-) and 1 neutral (N). The 4 bullish stocks (BA, BAC, CAT, and CSCO) are trading above their 50-day averages; BA has achieved a strong move relative to the average. I've rated AXP as 'neutral' (N), in that it has a pattern that suggests it could or should follow along to the upside; e.g., based on a bullish flag pattern after forming a bullish upside price gap. AA is lagging the others and its pattern suggests that it's more likely to break down, than up and so is rated bearish (-).
All the stocks in my next 6, are rated as bullish except Chevron (CVX). I rate CVX as neutral rather than bearish as it looks like it has some upside potential, but it's not proven yet. As you can see, this is a somewhat subjective process as people can interpret chart patterns differently. However, reliance on the 50-day average as my main rating criteria is fairly objective; i.e., the stock is either in an trend that is or has carried it above the 50-day moving average or it has not.
The group consisting of IBM through Coca Cola is a mixed bag at 3+ and 3N, but I haven't rated any as bearish. IBM, KO and JPM haven't yet pierced their respective 50-day moving averages, but all have upside momentum going for them. JPM is a little questionable in this regard, but IBM and KO not so much. INTC, JNJ and KFT are of course all above or well above their 50-day averages. INTC has a bull flag formation and looks like it could next challenge it prior high.
Group 4 next is a 2-2-2 split. There are two bearish looking patterns seen with PFE and MRK (same influences fundamentally). MCD and PG are rated as bullish. MMM and to a lesser degree, MSFT, I'm seeing as neutral; they appear to be following the more bullish acting stocks and thus don't have 'independent' strength so to speak. But the neutral group will probably not act as a drag on INDU either.
'Neutral' may be a bit of a misnomer as these stocks are advancing also, but havenâ€™t shown yet the kind of upside momentum that we've seen with the 'bullish' grouping of INDU stocks.
The last group of 6 stocks and which completes the 30 Dow stock charts, has 3 I've ranked as bearish, with 2 evaluated as neutral and only 1 as bullish. I'll leave it to you to group which stocks go where as far as 1 chart being bullish, 3 bearish and 2 neutral. This shouldn't be much of a challenge but if you don't agree with how the 6 break down for me as 2 bullish, 3 bearish and 1 neutral, please e-mail me for discussion.
The Dow 30 stocks are ranked by me as follows:
This analysis suggests that there's substantial upside potential for the Dow, and for the overall market, assuming that the 15 continue to march higher in line with their current and recent technical action. These 15 significantly outweigh the 7 that may lag or continue to work lower. If the 8 ranked as neutral just follow the 15 bullish stocks higher, OR simply go sideways, the effects of their movement will truly be neutral. The end result, stocks on balance work higher.
GOOD TRADING SUCCESS!!