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Lesson 5: NYSE 52 Week High Low Market Forces

This my favorite indicator of market breadth. We use breath as a technique in technical analysis to attempt to gauge the direction of the overall market. We do that by analyzing the number of companies advancing relative to the number declining. We use the term "Positive market breadth" when more companies are moving higher than are moving lower, and it is used to suggest that the bulls are in control of the momentum. Conversely, a disproportional number of declining securities is used to confirm bearish momentum.

This is a deceptively simple indicator -- we simple count the number of NYSE stocks making New 52-week Highs and subtracting the number of stocks making New 52-week Lows. The line is based on cumulative data, so the scale on the side is not relevant.  What is important is the recent direction of the line - up is healthy, down is sick. Think of this as the vital sign measurement for the health of the market.

Here is my classic version you see in the Market Comments.

In the top portion The High-Low Line (in green) can be used like the AD Line. One nice thing is that Net New Highs are not as volatile as other breadth indicators like Net Advances or Net Advancing Volume so our High-Low Line will not fluctuate like some indicators do. We also apply a 10 period moving average (yellow line) to identify upturns and downturns in the High-Low Line. This indicator is so stable we can track it with only a 10 period smoothing line because the High-Low Line moves very smoothly in one direction up or down.

On the bottom portion we look at the same line in a histogram, red is bad, black is good, but you can't run every-time you see red, it is more of an antennas up warning. The point is as long as red is coming up too often the market is not well.

You will note the little windows to the right of the chart. They are called zoom thumbnails. Think of these as magnifying glasses to give you a good look at the recent part of the chart.

I use the NYSE index because it is populated by a cross section of some 1,900 bigger and more stable stocks. You can also chart other exchanges with the 52 week High Low such as the NASDAQ. This chart below is the same time frame but using NASDAQ and then the Canadian TSX exchange, (at the time of this writing Canada is in really big trouble).

Wow look at the red, clearly this is nothing but dangerous.

The High Low indicator can warn of market trouble IF the problem is due to a gradual topping process. Of course it will not predict super sudden market moves like the May 6 2010 "Flash Crash". However it often warns of upcoming trouble that most people (even the pros) don't notice.

Let's see what happened in the financial meltdown of 2008. To begin with let see the warning signs here is March 07 to March 08. Notice the second window violates the 400 level (red line) in August 2007. This was when a few big mortgage companies like Country Wide lost their lines of credit. Many trades were starting to unwind.

Now lets look as the market begins to fall apart March 2008 to March 2009 we see the market tried to come back in the first part of the year and fall apart by the fall of 2008 when Lehman brothers filed for bankruptcy.

By 2009 the markets had hit bottom, the perfect time to get in would have been spring 2009 and as you can see the chart was going sideways, by fall 2009 a clear uptrend had begun.

This is why the 52 week High Low chart is my favorite. It keeps me clear of market trouble and lets me be aggressive when the market warrants it.

That 70s Show
A fundamental investment maxim is that, "A great company is not necessarily a great stock." No matter how good or bad a company’s management, no matter how large or small a company’s profits, no matter how bright or bleak a company’s prospects, the attractiveness of a company’s stock depends on its price. At some price, a great company’s stock is expensive; at some price, a lousy company’s stock is cheap.

In the late 60s there were a group of companies called the nifty 50. The Nifty Fifty were a group of premier growth stocks, such as Xerox, Emery Air Freight, Burroughs, Digital Equipment, Polaroid, and Coca-Cola, that became institutional darlings in the early 1970s. All of these stocks had proven growth records, continual increases in dividends (virtually none had cut its dividend since World War II), and high market capitalization. This last characteristic enabled institutions to load up on these stocks without significantly influencing the price of their shares. The Nifty Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts claimed that the only direction they could go was up. Since they had made so many rich, few if any investors could fault a money manager for buying them.

As the 50 stocks rose in value, the firms often used their shares certificates like they were cash to buy up other companies, making the core company bigger and on the bubble went. One conglomerate called ITT, branched out from telecommunications equipment to gobble up over 300 acquisitions. They were baking bread at Wonder, renting cars at Avis, running hotels, they were building military equipment, ships and even made parts for the space program. ITT touted its above average modern methods of management but the truth was it was just very good at raising money. The picture here is the ITT H.Q. main doors on 75 Broad street just down from where Goldman Sachs rules the world today.

The problem was the rest of the market was dead, people only wanted to buy these 50 stocks. Then, in the memorable words of a Forbes columnist, the Nifty Fifty were taken out and shot one by one. From their 1972–1973 highs to their 1974 lows, Xerox fell 71%, Avon 86%, and Polaroid 91%.  After the 1974 market crash, and it was a long long road to recovery, 1982 to be exact.

It Continued With Most Sell Offs
The 1970's were not the only example. Many pros were taken by surprise by the sudden market sell-off on Black Monday Oct 19, 1987 (see bottom panel the thin black line is NYSE prices). The famous trader Martin (buzzy) Schwartz, recalling that crash candidly admits "I was long, and I was wrong!".  Here is a television program from two weeks prior to the crash, and listen as "two experts" talk of how safe the market is and one of the experts (Marty Zweig) gets it right. You also could be smarter than many experts, if you used the 52 Week High Low chart. Look in 1987 how well our little indicator predicted trouble. If you had been using this chart you would have been out way back on October 12 and missed the worst of it. Or Perhaps even back on September 1 you would have seen the sideways warning and lots of red in the lower histogram and run!

Here is another look at what the charts looked like in the 2008 financial crisis (this is a two year version). There were lots of warnings way back in the fall of 2007. There were some pretty good signals and one whipsaw in October 2007, just before a significant peak. Also notice how the 10-day SMA of Net New Highs met resistance three times in the first half of 2008.

From the year 2000 -- The "dot com bubble" looked like this:

It is not all about bad news, let see what a healthy market looks like. This is from 2014 one of the greatest runs in market history. 
A chart like the one above gives you lots of confidence, be long and strong! Take bigger risks, play momentum stocks and all the hot new things the press and stock-twits is raving about.

Lets see a positive example, in 2014 you could have joined me and used the High Low chart to ride the Nasdaq from May 27 2014 to July 31, 2014:
That is only three months of investment at risk, but if you had used that to buy the broad based Nasdaq index QQQ you would have been diversified over 100 companies and earned $7.37 per share in stock appreciation and  $0.25 a share in dividends. For example: 1,100 shares would have cost $95,546 August you would have had $8,380 more in your account -- a return of 8.77% over only 3 months.  Sure there were riskier ways to get in like the juiced QLD etf that would have netted you 9.34% on the other hand you could have a high flyer on a "darling" Nasdaq stock like Apple, paradoxically returning only 6.9% in that period. You are NOT a computer, don't invest like one.  In my opinion trying too hard is not worth the risk -- stick with the stable un-leveraged diversified investment with simple trading rules.

Timing can be very important. Imagine driving a powerful sports car and you want to see what it will do if you hit that gas pedal. Below are two pictures of driving conditions, which one looks best for a little "need for speed"?

Well the answer is obvious, you should wait for better conditions before cranking it up. Same is true for protecting your hard earned investment account. Be patient, there will be a better time to invest. I use the NYSE 52 Week High Low chart as one of my guides of when to play it safe and when to rev up.  

In case you don't want to wait to read my weekly market comment, you can run your own 52 Week High Low Charts anytime on three major markets with these links:

The High Low chart is a very valuable tool that can be used to define the overall trend and identify meaningful trend reversals. Smoothing the indicator the yellow 10-day moving average reduces insignificant movements to focus on the general trend.

The underlying index favors the bulls when the smoothed Net New Highs line is positive and the bears when negative. Armed with this information, chartists can define a trading bias when looking at other indicators and aspects of technical analysis. An index with a bullish bias would warrant a preference for bullish signals or signals in the direction of the bigger up trend. Conversely, an index with a bearish bias would warrant a preference for bearish signals.

When the High Low chart moves sideways or drops it is a precarious time to play the markets. Pay attention to the NYSE High Low Chart. When the High Low line is pointing sideways or down avoid putting new investments to work or holding higher risk equities  -- it is seldom worth it.

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