In our last few posts we've been looking at how you can gauge the stock market's direction. In this post, we'll conclude this series by looking at how you can spot if the market's about to turn.
As we've discovered, observing how the general averages are acting is essential in helping you gauge the market’s future trend or direction. However, there are some key indicators that can give you a head start when spotting market turning points.
One of the things that we like to see happening to confirm that the market is strong and vibrant is the way that the NASDAQ Composite, the NASDAQ 100 and the chip sector are acting.
Watch the NASDAQ Composite, the NASDAQ 100 and the chip sector
We refer to the NASDAQ 100 as the NASDAQ Composite’s big brother. The NASDAQ 100 is formed of the 100 largest stocks listed on the NASDAQ Composite and includes giants such as Microsoft, Google and Cisco Systems. Chips are a common term for semiconductors. The main index for chips is the PHLX Semiconductor SectorSM and is commonly known as the SOX.
If the market is rising but being led by the Dow or the S&P 500, meaning that the NASDAQ, the NASDAQ 100 and the chip sector are lagging, it means that the rally (uptrend) is more prone to fail. But if the NASDAQ, the NASDAQ 100 and the chip sector are leading the market higher, it tells you that the rally is more likely to succeed. By watching the market every single day, we’ve noticed that these three key indicators act like a kind of giant magnet. In other words, when they are weak, they tend to pull and lead the market down, but when they are strong they tend to pull and lead the market up.
We like to watch the NASDAQ 100’s action in two ways. We look at the chart of the NASDAQ 100 and we look at the chart of the QQQs, which is the exchange-traded fund (ETF) that tracks the movement of the 100. By watching the QQQs, we can carefully study the behaviour of the NASDAQ 100. With chips, we like to watch the SOX and the SMH, which is the exchange-traded fund that tracks the performance of a number of major semiconductor companies. Included in the SMH are Intel, Texas Instruments and Applied Materials.
The NASDAQ Composite, the NASDAQ 100 and the chip sector are three key indicators that can give you early signals to act. We watch them very closely and we suggest you do too. The market has worked in exactly the same way since it began in the late 1800s. It is always about supply and demand and the way to analyse supply and demand is through looking at price and volume behaviour on charts. But many people are not aware of this key fact. When they ask for our take on what is going on with the market we always give them the facts based on what the market has been doing. But unfortunately some people get sucked into the media headlines and mistakenly believe that the facts we’re sharing with them are totally wrong.
For example, let’s say that the market has been acting really well and all the signs are showing that the institutional investors are buying stocks. That is a bullish indicator and tells you that the market is more likely to head north than sideways or south. But the news on TV, radio and in the papers may be mentioning things such as terrorism, war, recession, bear market, debt and other forms of negativity. The best investors in the world never get sucked into the pessimism of the media and always focus on the facts instead. There are going to be times where the market will be telling you that all is well but the majority of people will be saying the opposite.
Monitor the market every day
The market can be acting well, even when the news headlines are saying the opposite. It never surprises us when a person decides to challenge the market’s recent healthy behaviour. They think they know better than the market. This challenger nearly always turns out to be a know-it-all who is totally fixed in their thinking. This person might say something like, ‘But what about the price of oil?’, or ‘A recession is looming and that’s going to affect the market’, or ‘The dollar is putting serious pressure on sterling right now’. But every time we hear this type of talk, we always refer them back to supply and demand and remind them about price and volume action. We tell them that these are the facts and the facts say that right now all is well. We share with them what is happening and where we believe the market is likely to head in the immediate term due to its recent activity. We also tell them that this is how the market is acting now, but in another week or so it could be completely different.
You see, things can quickly change and from time to time the professionals alter their stance based upon new information. How this information will affect the market and stocks is constantly being fed to these professionals hour by hour and minute by minute. This is why daily monitoring is so important
Read the market like a professional
Institutional investors can be bullish one minute but then discover some new information that overrides their optimistic outlook. At the end of the day, to read the market effectively, you have to remember that it really does not matter what is happening news wise. Regardless of what the news or any market commentator is saying, if the price and volume action is positive, then that’s good, period. That goes for the downside too. If all the news headlines are positive but the market’s behaviour is saying the opposite, then you had better be thinking about switching into the safety of cash. The lesson here is simple. Do not look to the news or economic data to tell you what is going on or going to happen. Instead, find out what is really going on by studying the daily market activity using stock charts.
I hope you've found this blog series useful. If you'd like to know more why not download our latest free report Gauging Stock Market Direction.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO is a specialist in ISA and SIPP Investment and the pioneer of ‘Shadow Investment’, a simple way to grow your ISA and SIPP. Together with our clients, we have £57 million actively invested in ISAs and pensions*.
Our personal investment service allows you to look over our shoulder and buy into exactly the same funds as we are buying. These are investment funds that we personally own and so you can be assured that they are good quality. We are proud to say that by ‘shadowing’ us, our clients have made an annual return of 12.5% per year over the last four years** versus the FTSE 100’s 7.4%.
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* 15th November 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
** (31st December 2008 - 31st December 2012).
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