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Minyan Mailbag: When Will the Market Respond?


The glassy surface hides a dangerous wave building just below


Prof. Kevin -

When this rally started back in Oct., the buy signals were outnumbering the sell signals virtually every day which seemed like a forecast of things to come. Now, it seems sell signals are beginning to outnumber buy signals pretty regularly. Do you think we are going to actually see the market respond to the sell signals?

Minyan David

Dear MD -

The Bullish Percents measure the percent of stocks on the NYSE, NDX, SPX, Dow, or whichever index one is looking at, that are on point and figure buy signals. The Bullish Percent tells us two important things: the market context and the field position.

When the NYSE Bullish Percent, for example, is in a column of Xs, as it is now, that tells us that the overall context is positive, or put another way, that demand is in control. But knowing that demand is in control does not tell us much about present risk. The "field position" of a bullish percent chart tells us more about risk.

There are two lines of demarcation on the Bullish Percent chart that help us evaluate field position: roughly, 30% and 70%, though in the cases of very large bullish percent indices with less liquid stocks than the NYSE, such as the Nasdaq Composite, or S&P Small Cap 600, the upper level tends to become "high risk" at around 60%, instead of 70%.

So, what does the rough areas of 30% and 70% refer to? Remember, a bullish percent chart simply counts the percent of stocks on a given index that are on point and figure buy signals. A reading of 50% means that half the stocks on a particular index are on PnF buy signals.

An area of confusion relates to the "democracy" of a bullish percent chart versus the "plutocracy" of a capitalization or price-weighted index. In a bullish percent index, each stock gets one vote, and only one vote. By contrast, over on the S&P 500, GE gets many more votes than Avon Products (AVP). I will return to this idea of democracy versus plutocracy in a moment, but for now, back to the 30% and 70% risk levels.

The 30% level and below is the Green Zone, or low-risk area. When a bullish percent index gets down to this level it tells us that most everyone who wants to sell has already sold. The availability of supply to continue to push the market lower is limited. Conversely, when a bullish percent gets to the 70% level and above, the Red Zone or high-risk area, it tells us most everyone who wants to be in the market has already bought. Here, the availability of demand to continue to push the market higher is limited.

Below is a view of the NYSE Bullish Percent Index
(Chart courtesy
Dorsey Wright)

So, now let's get back to the democracy vs. plutocracy notion we brought up a moment ago.

Minyan David asks, "Do you think we are going to actually see the market respond to the sell signals?"

My answer, based on the bullish percent charts for the NYSE, Nasdaq Composite, NDX, SPX, Dow and Russell 2000, is that the market IS responding to the sell signals. Since the bullish percents peaked in January 2004, each reversal down and subsequent reversal up for the bullish percent charts for ALL of these indices has shown a lower high, which means fewer stocks participating in each successive rally.

The market has gone up since January 2004, obviously, but fewer stocks have been participating in the advance of the major indices.

So, in contructing my operating thesis, I note that the bullish percent charts for nearly all areas of the market show diminished participation since peaking in 2004....

... but the indices have obviously advanced... how?

The bullish percent charts say they have advanced on the backs of fewer and fewer stocks...

...but, importantly, even though the bullish percents show narrower and narrower participation, across virtually the entire stock market, the risk levels of these indicators remain very, very high.

Here are the various risk levels of the primary bullish percent indices.

Bullish Percent levels
NYSE 62%, peak 82%
NASD 52%, peak 74%
DJIA 60%, peak 92%
SPX 62%, peak 88%
NDX 56%, peak 94%
OEX 54%, peak 88%
Russell 2000 60%, peak 80%
S&P Mid 400 70%, peak 84%
S&P Small 600 64%, peak 84%

Data Investor's Intelligence

All of these bullish percent indices show diminished participation over the past two years even as the indices they track have advanced, a bearish divergence.

But wait, the risk levels are far lower than where they were in the 80s, isn't that good?

Remember, the 30% level and below is considered the "low risk" area. While the risk levels are less than what they were a year or two ago, they are far removed from low-risk levels. For now, most of the bullish percent indices above are in Xs, though deteriorating. Once they reverse to Os, if they do, then that changes the context from positive to negative, and raises further the probability that a resumption of the structural bear market takes place and the technical deterioration underneath the market's surface becomes more apparent to the naked eye.

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