Stock Market Strength And Short-Term Price Cycles

I recently posted on the topic of momentum and short-term market cycles. In this post, we'll look at market strength, as measured by 20-day new highs and lows, and those same cycles. Both of these are indicators tracked daily in the Trading Psychology Weblog, so that you can easily follow whether markets are gaining or losing momentum and strength.

The chart above takes us from March 13th through April 12th in the ES futures. (The last bar is the preopening futures for April 13th; the bar labeled H is the futures performance while the market was closed for the Good Friday holiday). Alongside each daily bar are two numbers. The top figure is the number of stocks on the NYSE, NASDAQ, and ASE making fresh 20-day highs. The bottom figure is the number of stocks making new 20-day lows.

A strong or weak market should expand new highs or new lows. It's when we see a stalling out of new highs or lows that reversals are more likely to occur, as market movements become more selective.

Note from the chart above how an expansion of new lows precedes price weakness in the S&P futures. Note also how an expansion of new highs often precede market rises. This is very useful information in anticipating market turns.

On the other hand, when we have strong expansions of new highs or new lows, I generally look for price movements to show continuation the next day. That is very useful in framing occasions to hold onto trades overnight, particularly during strong markets that have followed oversold conditions.

You can see from the chart one reason I am concerned about the recent market. Although we're hovering near multiday highs, we're seeing an expansion of new lows among stocks. This suggests that the market rise is becoming increasingly selective.

The new high/new low data are also useful in comparing the strength of one short-term cycle to the previous one for a longer-term trend perspective. If the market is in a longer-term uptrend, each successive short-term cycle should show expanded new highs. Conversely, a longer-term downtrend will expand new lows from one short-term cycle to the next. When one cycle fails to expand on the one previous, we often lapse into a longer-term consolidation, which frequently precedes trend change on that longer time frame.

Finally, tracking both momentum (Demand/Supply) and strength (New Highs/Lows) provides a multifaceted view of whether markets are gaining or losing the ability to sustain a trend. In my next post in the series, we'll examine how Sentiment enters the picture for a three-dimensional market view.