Tuesday, February 20, 2007

Identifying the Trend of Market Sentiment With the NYSE TICK: A Best Practice in Trading

Here is a best practice that will help you identify the trend of the market's sentiment in a single glance. It is a simple way of calculating the Adjusted NYSE TICK, as reported daily in the Trading Psychology Weblog.

In past posts, I have described the use of the NYSE TICK as a real-time measure of market sentiment. Because it captures the number of stocks trading at their offer price minus those trading at their bid at each point in time, it illustrates whether buyers are more aggressive in the broad market (they are accepting the offer price to get into stocks) or whether sellers are more urgent (accepting the bid price to get out of stocks). The NYSE TICK, when cumulated over time, is helpful in anticipating momentum effects in the market and in determining whether or not we're likely to hit pivot-based price targets. For this reason, a number of very nice setups can be identified using TICK, price, and volume.

The chart above, taken from e-Signal, is of the NYSE TICK on a 1-minute basis. Notice that the TICK values, displayed in candlestick bars, are accompanied by three horizontal lines. The first line, in red at the center, is the regression line over the past day of trading (i.e., the past 405 bars). This line is the best fit connecting the high-low-closes for each bar over that period. The blue lines above and below the TICK bars represent values that are two standard deviations above and below the regression line. When the TICK exceeds these levels, we know that an unusually large amount of buying or selling is occurring simultaneously among the NYSE stocks. Very often this is because program trading is hitting the market.

Note that, by looking a 3-minute or 5-minute bars, we can adjust the lookback period for the regression line and the standard deviation calculations, since the lines will always be based on the past 405 bars. I generally use a lookback period that corresponds to a relatively flat market condition (e.g., if the market has been flat over the past three trading sessions I'll look at a 3-minute bar of TICK), because that tells me the net buying vs. selling sentiment needed to sustain zero price change. If new TICK values consistently exceed the value represented by the regression line, that signals a shift toward bullish sentiment, and I would be leaning toward buying pullbacks in the TICK (i.e., pullbacks toward the lower blue line). If TICK values consistently fall short of the regression line value, that would indicate a shift toward bearish sentiment, and I would lean toward selling bounces in the TICK (i.e., upthrusts toward the upper blue line). When TICK oscillates evenly around the regression line, we often will have range bound conditions.

The key visual identification is the slope of the regression line for the NYSE TICK. If the slope is positive (the line is rising), we have increasing buying sentiment over time and vice versa. The slope of the regression line--and particularly a change in the slope--informs us of the trend of market sentiment. This is very useful in identifying shifts in the market's trend. In the above example, the slope is steadily rising and that--all other things being equal--would lead me to buy dips in the TICK that do not make fresh price lows. That would be one way to buy pullbacks in an upward trend.

Viewing the NYSE TICK-based sentiment in this fashion, you can filter your own entry signals. For instance, you might identify a bullish configuration in a chart pattern or in a CCI pattern, but only take that trade if the slope of the TICK (the sentiment trend) is positive. Many, many times the TICK distribution--the direction of the line--has kept me out of a bad trade by forcing me to go with the dominant market sentiment (which is set by the large traders). This is why identifying the trend of sentiment is, for me, a best practice.