Newton's third law of motion states that, for every force, there is an equal but opposite force. It's easily understood by sitting in a chair. Gravity pulls you down, but the chair pushes you up. If gravity were weak, sitting on the chair might bounce you up like a beach ball. If the chair's force were weaker, it would collapse, crashing you to the floor. If they're balanced, you sit pretty.
We've all studied this stuff, and it may feel old hat. But Newton's laws are pretty recent in human history. In fact, Harvard University was founded before Newton published his laws of motion and invented calculus.
If two forces work in the same direction, they make the force bigger, but if they work in opposite directions, they cancel each other out. And if one force is bigger than the other, then we get motion.
We also know about the forces of buying and selling pressure in stocks. Think of it this way: if there is huge buying in stocks and exchange-traded funds (ETFs) like a few weeks ago, they combine to propel the market higher than just stock-buying alone. If buying stops, we might expect indexes to drift higher until an opposing force pulls it the other way, like a ball attached to a rubber band. Hit the ball and it will go along in that direction until the rubber band yanks it back.
The Mapsignals Big Money Index (BMI) helps us visualize the third law of motion in the stock market. The yellow line is a moving average of big money buying against big money sells. A reading of, say, 75% means that 75% of all daily signals seen in the past 25 days were buys. When the BMI is at or above the red line, the market is overbought. But the BMI will continue moving in the same direction until an outside force acts on it.
Look at January 2020. The yellow line marched higher as buying propelled the market higher. Suddenly, it started to fall as sellers arrived. In our example of the ball on a rubber band, the market is the ball. It continued rising higher. The yellow line is the rubber band. The rubber band started pulling down because the sellers showed up. But it took a while for the market to follow suit.
Well now, here we are in a similar setup six months later. The BMI stalled and is starting to fall. The market has seen more volatility recently. In the absence of data, logic dictates that we are overbought. What goes up must come down, right?
Now the data is backing that up. This means that we are likely heading for more downside. Lower prices are good for opportunists, though – volatility equals opportunity. I prefer buying stocks when no one wants them. To buy when everyone is buying adds risk, and then when the force turns, you're left holding the bag.
I see a great buying opportunity around the corner. Why? Sellers are starting to show up. It has been nearly three months since we've seen any red sells.
The chart below is another way to visualize the Big Money Index. Here we just net out buy and sell signals and display them as net buying or selling. A green bar is a net buy day, and red is a net sell day.
Weeks ago, we had that record-breaking buying. As I told you at the time, that's usually not bullish. When we are overbought and everyone piles in to buy, it smells like a blow-off top. That's the big circle off to the right.
Then I told you that the buying had suddenly petered out. It slowed down immensely. The force reversed. Red is starting to crop up for the first time in months.
Here's why I look to the BMI so much; it tends to forecast what's to come. Big money moves markets. That makes sense: the biggest players in the stock market will have the most influence. They also tend to be smart and opportunistic.
The BMI shows that big money likes to start selling when everyone is buying. And we now see that sellers have finally started to overcome the non-stop buying.
As we observe in the second chart, we rarely see a singular red stick. Red and green come in waves … small at first and then intensifying. Then it ebbs and gives way to the opposite force.
Now is the time to have your shopping list of great stocks ready. Remember, I told you in the depths of March when the BMI was deeply oversold that was a great time to buy stocks. Indexes rallied roughly 40% since then. Now we are likely topping out as sellers show up.
To see where the market is going, we look at where it flows. But the real flow is the flow of big money. It tells us what's likely coming next. Author Banani Ray said, "Flow is the nature of energy; flow is another name of life."
When markets go straight down or straight up, it is like a force stretching the rubber band. Eventually it snaps back. We had extreme selling that snapped back to extreme buying, which now needs to snap back. The very first hints of a turning tide are here. History suggests that lower prices are just over the ridge.
I know which stocks I want to buy … do you?
The Bottom Line
We (Mapsignals) are bullish on high-quality U.S. equities in the long term, and we see market pullbacks as areas to pick up great companies.
Disclosure: The author holds no positions in any mentioned securities at the time of publication.