Apologies in advance for the very busy chart. If you click on the chart, the data will be clearer, and the explanation below will help in making sense of the indicator.
The basic logic of the indicator is contained in my prior post; we're looking at where each stock in a basket of 40 closes relative to its prior day's range. If the stock closes above the high of the prior day, we label that stock as short-term bullish; if the stock closes below the low of the previous day, we label it bearish. That is because, day over day, we are accepting value at higher or lower price levels. If the stock closes within the prior day's range, we label its short-term trend as being in a range.
First look at the red line, which is the number of stocks in the basket qualifying with bullish readings. We see the liftoff--broad bullish momentum off the July lows--and now the dwindling readings as the market appears to be in a consolidation/topping mode.
At the same time, we can see from the yellow line that the number of stocks with bearish readings has been creeping higher and recently has been exceeding the number of shares with bullish status. Observe how the number of stocks with bearish (yellow line) readings peaked ahead of the market bottom in July; this behavior is similar to what we saw in our recent look at five-day new highs and lows.
Finally, if we focus on the light blue line, we can see the elevated number of stocks trading in range mode, a useful alert to the recent consolidation/topping that we've been seeing in the S&P 500 Index (SPY; dark blue line). It is not unusual to see a peak in stocks trading in range mode ahead of market reversals, as happened at the July lows.
Note that Friday, which started out looking like a trend day to the downside, actually qualifies as a range day, as we had two stocks bullish, eleven bearish, and 27 closing in Thursday's range. That tempers my expectations for Monday and will have me watching how we open relative to Friday's trading range.
Seeing what is happening in broad market averages can help us gauge action in individual shares, given that most stocks are correlated with the indexes. What we're seeing in the recent posts, however, is that the reverse is also true: the behavior of a cross-section of stocks in a basket can illuminate what is happening in the broad market.
Creating indicators of this type offers a quick way to obtain a bottoms-up view of market behavior. I will be posting more of these indicator readings to the blog and updating readings via Twitter. The Twitter feed is free; you can follow the last five tweets on the blog under "Twitter Trader" or you can follow the entire stream here.
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