Wednesday, July 02, 2008

When Trending Trends and When It Ends

If I had to describe my trading approach in a nutshell, it would be to identify what markets have done historically under a set of conditions and then observe whether or not this scenario is playing itself out in real time. We've had an oversold market that, based on historical precedent, should have led to a sharp reversal. Tracking such indicators as the Cumulative NYSE TICK, however, it's been clear that buyers have been absent and that the market has not been following its historical script. Some might call that a failure of historical indicators; I call it useful, practical information.

Above we see how the indicators have been weakening (kudos to Decision Point for the charts). New lows among NYSE common stocks have expanded beyond their March levels (top chart; click for greater detail); the advance-decline line for NYSE common stocks (bottom chart) has also been making new bear market lows.

Notice in the bottom pane of the second chart that the volume-weighted advance-decline line for NYSE common stocks has been much weaker than its traditional counterpart. This suggests that stocks are falling on higher volume than they're rising: just another sign of institutional bearishness.

When indicators and sectors are in gear, we have a trending market. Distinguishing trending markets from ones that are likely to reverse is one of the great challenges of trading at any time frame. Knowing what markets "should" do based on precedent--and observing what they *are* doing--is helpful in making the distinction.


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