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MARKET TIMING


Timing Techniques Using The Bullish Percent Index

04/23/10 12:04:09 PM
by Ron Walker

The bullish percentage index is a powerful tool that will increase your odds of determining directional moves in the stock market. Timing is everything, and using market breadth indicators such as the bullish percent index will make you a punctual trader.


Security:   $BPSPX, $BPNYA
Position:   N/A

Chart indicators help us read and predict future price movement. Indicators are nothing more than representations of mathematical formulas usually based on price or volume. In recent years, hundreds of indicators have been created. With so many choose from, it can be an overwhelming task to figure out which indicators work best and have the highest rate of accuracy. So many indicators overpromise and underdeliver. Often, they even produce false signals, leading to a colossal blunder of miscalculations for unsuspecting traders.

Trying to sort through countless technical indicators can be a daunting task. So many traders/investors fall in the trap of setting off on a quest to find the perfect indicator -- until they realize there isn't one. Others fall prey to the mentality that more is better, so they clutter their charts with so many indicators that confusion than clarity is often the result.

I don't claim to have found the perfect indicator, but I have seen my odds increase when I use market breadth indicators to help determine directional moves. When market breadth indicators are in agreement with momentum indicators and/or trend-based indicators, it tips the scales in my favor. Using market breadth indicators can also help shield a trader from tremendous risk in the stock market. Market breadth indicators aren't perfect, but they have an excellent track record of being right more often than not. Market breadth indicators allows a trader to know the underlying strength of stock market movements in an upward or a downward direction.


FIGURE 1: $BPNYA, $NYA DAILY. When the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. Note the divergences that accompanied major turning points in the market. The NYSE could be carving out another divergence at this time with $BPNYA, but $BPNYA must make a lower high. A bearish divergence appears to be currently under construction (see dotted red lines).
Graphic provided by: StockCharts.com.
 
One of my personal favorite market breadth indicators is the bullish percentage index (BPI). It is a calculation that is applied to indexes (a group of stocks) rather than an individual stock. The bullish percentage index (BPI) is calculated by taking the total number of issues in an index that are generating buy signals on point & figure charts and dividing it by the total number of stocks in that particular index. Analyst John Murphy discusses the interpretation of the indicator in his book The Visual Investor: How To Spot Market Trends. Murphy's rules of interpretation for using the bullish percent index are simplistic; when the BPI is above 70%, the market is overbought, and conversely, when the indicator is below 30%, the market is oversold. The long-term readings of the NYSE bullish percentage index in Figure 1 illustrate this. Note the 2003 and 2009 bottoms both formed bullish divergences below 30%, while the 2007 top formed a bearish divergence after it broke below 70 and rallied back up to the 60s.

Keep in mind that overbought (70%) and oversold (30%) levels take a long-term approach for interpreting bull and bear markets. During the bull market run from late 2002 to 2007, the BPI of the NYSE didn't tag 30% until the bull market was coming to a conclusion in late 2007. Most corrections during that bull run were near the 50% level (Figure 1).


FIGURE 2: $SPX, $BPSPX DAILY. Savvy traders can plot the BPI as a line and place either a five- or 10-day MA on the chart. Traders can will sell the market if the BPI crosses below their moving average of choice, or go long when it crosses above it. Note the most recent bearish cross on April 19.
Graphic provided by: StockCharts.com.
 
The BPI works well when plotted as a line with the five-period moving average (MA) or 10-period MA alongside it. Exponential moving averages (EMAs) can also be used. In this example we will use the S&P 500 as our underlying index beside an EMA.

The lower window in Figure 2 displays the BPI of the Standard & Poor's 500 ($BPSPX) plotted as a line with the five-day EMA placed with it. The strategy here is simple: Sell the market when the BPI crosses below the moving average, and buy when it crosses above the respective moving average. When the BPI crosses above or below the five-day EMA, it triggers the signal to buy or sell.

A trader can also mark the intraday low or high made during the session when the crossover takes place, and wait for prices to close below or above that level on the desired index before entering a position. Waiting for a confirming close would validate the signal by allowing prices to receive a follow-through.

Sometimes the BPI turns before the market, while other times it will turn with it. Figure 2 shows that this indicator gave timely signals at both the January 2010 high and February 2010 low. By using this technique, you will know how strong most of the stocks are in a particular group as opposed to how the index is doing.


FIGURE 3: $NYA, $BPNYA DAILY. The massive bearish divergence that appeared on the NYSE bullish percentage index forewarned of the danger in the fourth quarter of 2007.
Graphic provided by: StockCharts.com.
 
The BPI can also form divergences with an index, forewarning of an impending change in the long-term trend. The upper window in Figure 3 displays a daily chart of the NYSE Composite index ($NYA) from 2007, with the NYSE bullish percentage index ($BPNYA) in the window below it. Note that the NYSE bullish percentage sported negative divergence with the NYSE Composite Index, marking the end of the bull market in October 2007. If you glance at Figure 1 and back again, you can see that bullish divergences also marked the 2003 and 2009 bottoms.

Did you happen to note that another possible bearish divergence was currently forming on Figure 1? Prices have recently moved to fresh highs on the NYSE, up from the 2009 lows, but the NYSE bullish percent index has not yet moved to a new high. If the NYSE BPI makes a lower peak, it will complete a divergence with price (see dotted red lines on Figure 1). Should the bearish divergence be completed, it will likely result in a harsh correction for the major market indexes.




Ron Walker

Ron Walker is an active trader and technical analyst. He operates an educational website dedicated to the study of Technical Analysis. The website offers free market analysis with daily video presentations and written commentaries. Ron is a video pioneer, being one of the first to utilize the internet producing Technical Analysis videos. His website is thechartpatterntrader.com

Website: thechartpatterntrader.com
E-mail address: thechartpatterntrader@gmail.com

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