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Context Helps Timing, But Doesn't Control It

By

But I'm not tired yet!

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Yesterday, in Evaluating Market Context, we looked at how the bullish percent concept works and how it can help us evaluate market context. Now that we know what the bullish percent can do, it is important to understand what the NYSE Bullish Percent does not do. It is not a strict timing trigger. The bullish percent concept is simply a tool for measuring risk in the market. I believe it is best used as a tool in addition to "something else."

Let's take a look at the NYSE Bullish Percent, which we used as an example yesterday. The NYSE Bullish Percent (available through Dorsey, Wright & Associates) is not a measure of what the Dow Jones or the S&P 500 is going to do, because these indices measure just a handful of stocks. The S&P 500 is capitalization-weighted while the Dow is price-weighted. In other words, much of their movement is controlled by a relatively few number of stocks. The NYSE Bullish Percent, on the other hand, is a simple voting mechanism constructed the way most people build their portfolios: one stock -- one vote. Do you capitalization-weight your portfolio?

Ok, so the NYSE Bullish Percent is a democratic risk indicator, how does that help us? Risk indicators are as important as timing triggers. The value of the Bullish Percent concept is that it always gives you a clear picture of current risk in the marketplace. Suppose you are using a combination of MACD, stochastics, DeMark or some other types of indicators to work your positions. The Bullish Percent concept used in conjunction with your other indicators can tell you when you're betting dollars to win twenties, or when you're betting dollars to win nickels.

As we pointed out yesterday, the context remains positive, but we have moved into the High-Risk zone. A question often asked is, "What would it take for the NYSE Bullish Percent to reverse to Os indicating a change in context? Right now, according to data from Dorsey Wright, the NYSE Bullish Percent is telling us that 70% of the stocks on the NYSE are on point and figure buy signals.

Think of two piles of stocks. One pile contains those stocks on a point and figure buy signal, the other pile contains those stocks on a point and figure sell signal. In order to move from Xs to Os on the NYSE Bullish Percent chart, we need a total of 6% net new sell signals. In other words, every day a number of stocks may change piles. To move to defense, we need a net 6% change from buy signals to sell signals.

Lately, I have been focusing on the quality of the stocks being added to the new buy signal pile. As I have noted, the new buy signals over the past four-to-five trading days are concentrated in stocks with poor technicals. The tide may still be rising, but in my view it has crested and is now washing the debris onto the beach.



No positions in stocks mentioned.

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