Trading Between the Lines
Breadth, volume, sector leadership as vital as price action.
Studying the underlying characteristics of a day in the market is one of the secret weapons of all successful traders. Beyond price action, one has to consistently review such things as breadth, volume and sector leadership to better understand what's taking place.
- Breadth is a measure of advancing stocks versus declining stocks and gauges the expanse of the move. While this number is quantifiable, the interpretation has to be somewhat methodical and should only serve as a guideline. Typically I use breadth to signal possible coming reversals in the short and longer term. For example, in the fall of 2007, one of the ways I knew to start lightening up or become suspect of the continuous advance in the NASDAQ was due to its narrow breadth. Each day the market seemed to advance in great strides, but the underlying breadth was consistently narrowing. The move was being made only in the biggest names such as Google (GOOG), Apple (AAPL) and Research in Motion (RIMM), while others were stalling out. While this didn't mean one had to start shorting, it simply was a warning sign and worthy of respecting.
- Volume acts as fuel for an advance or decline and signals what institutions are doing. Big money in the form of mutual funds or hedge funds are always needed to push a move further in one particular direction. They are typically longer term in nature and when volume is light it may signify that these big players are not present and one has to be suspect of just how long the move will last.
Just this week we have seen a big reduction in volume as the market continued to advance. This has had me somewhat skeptical and has sparked me to raise further cash. Volume should always be reviewed when trading individual stocks as well. If a substantial move is taking place but doesn't possess an increase in volume above what's typical in a particular stock, it must be viewed with a skeptical eye.
- Sector leadership gives us a better indication of just what the masses are really thinking. Despite what you hear on TV, radio or read in the newspaper, money managers can feel one particular way about a market or sector but actually be moving money into different areas.
It's much more important to watch what sectors are moving a market than it is to listen to a mutual fund manager tell you where he thinks the market will go in a few months and what will take it there. Bulls typically want to see a market led by stocks signaling economic expansion, such as retail and technology, while bears will point to defensive groups such as utilities, healthcare and commodities. Understanding what's moving a market will help you to better measure the general feel for where the big money believes the market's headed.
Recently, for example, the transportation index as noted by the iShare (IYT) has shown relative strength and broken out of a downtrend started in 2007. This is typically a bullish sign as transports tend to lead the general market. On the other hand, the leadership groups over the last several months have been the commodity stocks such as gold, silver, oil and grains. This is hardly a group that signals economic health and rather is a group that signals economic instability.
It's important to periodically review the key sectors to see just what they're doing in order to get a better feel for what the market may have in store.
Here are some bullish and bearish characteristics that I'm currently watching.
- Retail and Transports continue to show relative strength.
Small caps are also showing relative strength.
We've recently seen a few high volume accumulation days.
Breadth on advancing days has been broad and narrow on declining days.
- Volume over the last few days has been declining steadily.
Defensive sectors remain the most technically healthy.
We've yet to push through key technical levels in the major averages.
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