The opposite of a trending stock market is not a choppy market. The opposite of a trending market is a rotational market. Many times, the market will indeed follow themes, but the themes play themselves out in relative terms. Perhaps growth stocks are outperforming defensive sectors; perhaps small caps are outperforming large cap stocks. The patterns of what is strong and what is weak define the themes for a given market session.
Part of the challenge of short-term trading is that we cannot blindly assume that yesterday's patterns of strength and weakness will play themselves out today. Rather, we have to first sit back and observe the various components of the market and how they're behaving to identify today's market personality. This is key to trading psychology: an active trader (as opposed to an investor) does not attempt to predict market action based on top-down criteria. The active trader waits to see the bottom-up activity that reveals the patterns of trading here and now.
Several tools are helpful in assessing the market's personality from day to day:
1) Volume (and especially relative volume) - How does the volume at a give time of day today compare to yesterday's volume at that time of day and the usual volume at that time of day? If volume expands meaningfully, we want to see how stocks are behaving with the new market participation. This will tell us who is participating and whether that participation is showing up in trending behavior or in the relative strength of one market segment vs. another. Conversely, when volume dries up, we want to see how different parts of the market are impacted by the lack of participation. What moves directionally in a quiet market tells us an important story.
2) NYSE TICK - How many stocks are trading on upticks vs. downticks as we move forward in the session and--most crucially--how is the upticking or downticking impacting the price of various segments of the market? We recently had a range-bound day in the morning that displayed strong selling pressure with negative TICK numbers. Many parts of the market failed to make new lows on this selling. The absorption of the selling pressure alerted the savvy trader that sellers would be trapped and, sure enough, their covering helped create a trending move during the day. Very often, new extremes in the TICK numbers alert us to strong buying or selling interest--and how that interest moves the market (and different parts of the market) tells an important story.
3) Short-term overbought/oversold readings - I use the adaptive moving average system from John Ehlers, which shows how shorter-term moving averages cross below and above longer-term ones. The adaptive part is that the readings for short-term and longer-term change depending upon the cyclical character of the market. As Ehlers has pointed out, this helps remove whipsaws from the indicator. Basically I want to see short-term oversold levels occurring at successively higher price lows or short-term overbought levels occurring at successively lower price highs. When sector ETFs show different patterns of overbought and oversold, that highlights a rotational market. In a strongly trending market, the cyclical quality of the price action will break down and we will get prolonged overbought or oversold readings across multiple market sectors.
An important edge comes from being quicker than other participants to see how the market's character is playing itself out--and how it might be changing over time. Many traders underperform because they fail to see relative themes playing out in real time. If your trading is habitually bullish or bearish, you know that you're not doing a good job of assessing and following the personality of the market.
Further Reading:
.
Posts
