* Who is in the market? - This is defined by volume and relative volume. More market participation means more institutional participation and greater volatility of price movement.
* What are they doing? - Are market participants leaning to the buy or sell side? Is that leaning shifting over time? As we shall see, the distribution of stocks trading on upticks versus trading on downticks is helpful in reading participant behavior.
* Where are they doing it? - We hear traders talk about "key levels" all the time. Sometimes these are based on support/resistance; sometimes based on ratios and inferences from prior moves. Whatever. When we see significant shifts in "who is in the market" and "what they are doing", the price levels at which these shifts occur are meaningful. If we break to the downside on significantly elevated volume and stocks trading on downticks, we should not revisit the level at which the break occurred if this is, indeed, the start of a market downleg.
Now let's add a fourth question to our ongoing monitoring of the market:
* How well are they getting it done? - How much price movement are we seeing as a function of a given level of buying or selling? Are buyers or sellers moving price meaningfully higher or lower, or are they having difficulty breaking to new highs or lows. Very often, before the bulls take over from the bears or vice versa, we see one side failing to move price significantly. That side becomes trapped when the other side takes over and needs to cover, contributing to a move in the other direction.
Above we see a chart of a two-hour moving average of the NYSE TICK (red line) versus SPY (blue line) from the start of September to present. Note how, during the run up to highs in September, the distribution of NYSE TICK values was not meaningfully positive. The amount of time spent below the zero line was as great as the amount spent above--and actually a bit greater as we moved closer to the highs. This was one of the yellow caution lights that had me concerned about the quality of the market highs we were seeing.
Notice how, at the start of the downtrend, we broke to significant new lows in the $TICK measure. That shift in distribution told us that sellers had taken control of the market. Note that this occurred relatively early in the decline, when SPY was about 289. Stocks persistently traded on downticks.
In recent sessions, we have seen buyers come into the market, as we can see by the two-hour measure going into positive territory, but note that they are not "getting it done". The buying bursts, mostly short-covering, are able to retrace only a relatively modest fraction of the prior price decline. At some point--and I'm prepared for it to come soon--the selling pressure will have trouble making new lows and buyers will step in more aggressively, with higher $TICK readings. That is how bottoming processes begin.
Conversely, if we start the week lower on expanded volume and very negative $TICK readings, then we know we have not yet hit a downside equilibrium. We can read market psychology by continually updating our assessment of volume, distribution of upticks and downticks, and the ability of both of those to move price. This is not so much a matter of "predicting" what the market will do as identifying in real time what is actually occurring.
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