Market Breadth: Point & Figure Internal Indicators
Before the dawn of computers, the point-and-figure (P&F) technique of charting was popular among market strategists on Wall Street. Back then, with P&F charting, a pencil and paper were enough to keep up with many charts on a daily basis. Then, as the internet brought trading to the general public, P&F charting techniques were revisited and re-popularized because they can weed out market noise, point to major breakout, resistance and support levels, and forecast directional moves in price.
The powerful attributes of P&F charting lend themselves exceptionally well to the study of market internals. This section concentrates on two P&F-based charts that have become widely used as internal indicators: the percent-over-50 and percent-over-200 indicators. By learning to read market internals, you will be able to read the underlying forces between supply and demand and to make more informed trades.
The P&F chart of the percent-over-50 is an early indicator of a new short-term trend in the market, and can be read much like any P&F price chart. By applying the P&F charting technique to this percent-over-50, market technicians can track the movements in value and quickly find breakout, resistance and support levels.
One of the simplest short-term buy signals in technical analysis revolves around buying stocks when they cross above their 50-day moving average. While this is not always a profitable strategy with individual stocks, a high percentage of stocks crossing above their 50-day moving average can indicate that the market is in a bullish, upward swing - at least for the shorter term.
The percent-over-50 P&F chart traditionally uses a box value of 1% with a three-box reversal. As a downward column of 'O's reverses into a new column of 'X's, the percent-over-50 chart indicates that stocks are crossing above their 50-day moving average. If the column of 'X's overtakes the previous column of 'X's, a bullish short-term trend is confirmed. The opposite is also true: when a column of 'O's moves past the previous column of 'O's, the percent-over-50 chart confirms a bearish short-term trend. As a column of 'X's or 'O's approaches the extremes of the chart, the percent-over-50 signals an overbought or oversold condition, and a reversal at these levels could mean a significant backlash.
Using the percent-over-50 indicator in a long-position trading strategy might involve looking for three or four progressively narrower markets in a confirmed upward trend. For example, start with the NYSE percent-over-50. If the chart gives a bullish signal, move ahead to the NYSE sector indexes to see which one is the strongest. Move further still and determine which industries in that sector exhibit the most bullishness in their percent-over-50 chart. By finding these industries, the trader can focus on a much narrower field, and, by getting an idea of which companies are leading the market, has a higher probability of finding a winner.
Here is an example chart of the NYSE percent-over-50
As you might imagine, the percent-over-200 shares many similarities with the percent-over-50. In fact, it's virtually the same indicator except it measures stocks trading above their 200-day moving average. Since the 200-day moving average of a stock price moves far slower than the 50-day moving average, a cross above or below this value is usually more significant and longer-term in scope.
All the traditional rules of P&F charting apply here. The percent-over-200 is commonly charted with a 1% box value and a three-box reversal. Just like the percent-over-50, the percent-over-200 is an oscillator that charts values between zero and 100. The extremes of the chart point to more dangerous overbought or oversold conditions, where a reversal can mean fast-changing market conditions.
When designing a trading strategy using the percent-over-200, try incorporating the percent-over-50. For example, after finding an industry that is showing a longer-term bullish trend on the percent-over-200 chart, watch for a reversal in the percent-over-50, which signals a more conservative stop-loss in that industry.
Movements in an individual stock position should always trump a broader market indicator if they aren't working together. Don't enter a single position because the broader market was in an uptrend.
Here is an example of a P&F chart of the Nasdaq percent-over-200:
Bullish Percent Index
In 1955, a company named Chartcraft (now known as Investor's Intelligence) used P&F charting to develop a broad-market indicator called the bullish percent index. The index was first applied to the NYSE, but can now be found representing most markets and sectors. Each evening after the market closes, the bullish percent index is calculated as the percentage of stocks flashing a buy signal on their P&F chart in relation to the total number of stocks in that market. This is plotted as its own P&F chart. Because the value of the chart is a percentage, it will always range from zero to 100.
The bullish percent index is always in one (and only one) of six stages. These six stages signal the mode of the market (bullish or bearish), and for each mode there is an appropriate strategy. Here is a list of the six stages and what they mean:
|Bull confirmed - Bull confirmed is just as it sounds - the most bullish signal the index emits, giving traders a green light to take on multiple long positions with confidence. In the bull confirmed phase, the bullish percent index has a column of \'X\'s on its right edge, and this column must have surpassed the next column of \'X\'s over to the left by at least one square. Since a market that is in bull confirmed mode is upwardly trending, directional indicators such as moving average convergence divergence (MACD) are more appropriate than oscillators during this phase. |
Bear confirmed - Again, just as it sounds, the bear-confirmed phase is the most bearish signal the index gives. In this mode, the bullish percent index has a column of \'O\'s on the far right edge of the chart, and this column must surpass the next column of \'O\'s to the left by at least one square down. Since a market in the bear confirmed mode is trending downward, only short positions should be considered, and directional indicators are again the weapons of choice.
Bull correction - The bull correction mode, following only a bull confirmed phase, is a sideways market or a market experiencing a correction after a bull-confirmed phase. The chart features a column of "O\'s on the right edge that has yet to pass the last "O\'s column. Long positions should be taken with caution because a bull correction can reverse into a bear confirmed. During the bull-correction mode, look to oscillators like stochastic for insight into timing trades.
Bear correction - A market in the bear correction phase, following only a bear-confirmed phase, is also a sideways market, and it is experiencing a correction from bear confirmed. A bear correction features a column of \'X\'s on the right edge of the chart that fails to surpass the last column of \'X\'s. Again, use short positions with caution, and use oscillators instead of directional indicators with the charts.
Bull alert - The final two phases of the bullish percent index involve overbought or oversold conditions. On the bullish percent chart, readings above 70% are considered overbought, and readings below 30% are considered oversold. The bull alert phase is simply a reversal into a new column of \'X\'s from below 30% on the chart, and it indicates that the index is oversold and due for a bounce. As soon as the index signals a bull alert, traders can take long positions with caution until the \'X\'s cross back above the 30% line.
Bear alert - A bear alert is simply the opposite of a bull alert, except to signal a bear alert, the index must be crossing below the 70% line with a column of \'O\'s. It is important to remember that for a bear alert to signal, the column of \'O\'s must actually cross back below the 70% line. During a bear alert, the market is overbought and due for a sell-off. Take short positions with caution until the market reverts back to bull confirmed. During alert phases, it is a good idea to take quick profits (10-15%) because there is a good chance the market will reverse.
Here are charts showing each of these phases:
A good trading strategy using the bullish percent index would include matching the signals of the market, sector and industry you are looking to trade. To further confirm the signal, try incorporating the percent-over-50 and percent-over-200 charts as well. Try applying the six stages of the bullish percent index to the percent-over-50 and 200 charts to read their signals more clearly. Stockcharts.com provides free P&F charts of many sector and industry bullish percent indexes.
Here is an example of a NYSE bullish percent index:
Point-and-figure charting, by removing the time element from the chart and recording only larger price moves, can filter out market noise. The P&F chart of the percent-over-50 signals new short-term trends, and market technicians can use it to find breakout, resistance and support levels quickly. The percent-over-200 measures stocks trading above their 200-day moving average, a condition usually more significant and longer-term in scope. The P&F chart of the bullish percent index, by occupying a particular phase, displays the market's condition, and, as such, indicates an appropriate strategy.
Market Breadth: Conclusion
A chart that plots day-to-day price movements without taking ...
The amount of price movement required to shift a chart to the ...
The minimum price change that must occur before the next mark ...
A type of technical analysis that uses point and figure charts ...
An indicator or chart pattern that provides evidence that the ...
The use of an additional indicator or indicators to substantiate ...
See how traders use count analysis on point and figure charts, and learn why this method differs from more traditional types ... Read Answer >>
Find out what signal confirmation is and some common strategies used to confirm trading signals concerning the tendency of ... Read Answer >>
Learn how traders identify false signals in the market when using indicators and strategies to better identify true market ... Read Answer >>
Learn how to use Microsoft Excel to calculate the Sharpe ratio, an investing tool useful for assessing the relationship between ... Read Answer >>
Learn about a number of various technical indicators traders and analysts use to define and confirm the existence of a bull ... Read Answer >>
Discover the various signals of bull market tops and what traders and analysts look for as signs of an impending bearish ... Read Answer >>