I often get asked by my readers where I think the market is headed. To the surprise of many, I never make a prediction, and quite frankly, am not good at making arbitrary market calls.
However, once I get the correct signals, I have a good feel for when it is time to get heavily bullish or bearish with my positions. This is when I make the most money.
Here are five questions to ask yourself when assessing the market:
- What are the major support and resistance (S/R) levels?
Marking support and resistance levels is the most fundamental, and powerful tool for traders. When you know where major S/R levels reside, you will be less apt to overreact to volatile, yet insignificant market noise.
Take this past week as an example. Early in the week we had three bullish days that had many pundits and bloggers pounding their fists saying the correction was over. The astute trader who marked the major S/R points knew it was too early to make a prediction. The SPY had not broke out over price support or the 50 day moving average. A few days later many of those same pundits have turned into bears, yet hardly anything has changed. The SPY ended the week right where it began! Until we get a break of the trading range, nothing has been confirmed.
- Is Volume Showing Accumulation or Distribution?
Volume is what makes the market go. You are not going to see a strong trend without accumulation (uptrend with strong volume) or distribution (downtrend with strong volume). Strong accumulation or distribution tells you that there is a strong probability the trend is for real.
The SPY is currently a tough read. While there seems to be distribution, there have also been some high volume up days as well. It will probably take some time to get a legitimate volume signal. It will most likely come when there is an S/R break as well.
- Is the Market Confirmed by New Highs/Lows?
When the market makes a move, the ratio of new highs to new lows need to confirm the trend. If there is not confirmation, you must take the roll of a sceptic. Chris Perruna made a great call during the up move early in the week. While the markets were bouncing, more stocks were making new lows compared with new highs.
- Is the market confirmed by the ratio of breakouts vs breakdowns?
Similar to the ratio of new highs to lows, I always take note of the breakout versus breakdown ratio. Every night, I screen for trending stocks that are breaking out or down by 3 percent or more on heavy volume. A key here is that I screen trending stocks. These stocks are more likely to show real moves, unlike the meaningless bounces of range bound stocks.
- Is the market confirmed by market leaders and momentum stocks?
When you run a daily breakout scan and create a watchlist based on it, you will have a good feel for the market’s leaders and in play momentum stocks. A strong market move needs confirmation from the momentum leaders. For example, if the market makes an up move, yet AAPL, BIDU, RIMM, EWZ, ICE, GES, MA, CROX and POT languish, I am skeptical of the move.
There you have it. A simple yet effective way to understand the markets.