Market Overview

Do The Bulls Have The Edge?

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Do The Bulls Have The Edge?

One of the real keys to success in the stock market is to have a thorough understanding of the time frame one is attempting to operate in. For example, long-term investors needn't worry themselves too terribly much with every move on the charts on a daily basis, as staying in tune with the major cycle is likely the goal.

Conversely, traders looking to produce winning trades on a daily basis probably aren't too concerned with macro issues such as monetary policy or valuations.

Related: The Bulls Have Cause For Celebration, But Can It Last?

However, even fast-money traders recognize that it can be beneficial to keep an eye on the big-picture environment. After all, knowing what type of market one is dealing with can be helpful in knowing what short-term strategy to employ, what sectors to try to exploit, etc.

Can The Breakout Be Trusted?

Although the market remains conflicted, it is safe to say that the environment has been improving over the past couple of weeks. Wednesday's buy signal is yet another sign that the bulls may have the edge at this stage.

One of the best ways to judge whether or not a move is for real in the market is to check the "oomph" behind the move. In other words, a new leg to the upside should be accompanied by a fair amount of momentum if it is expected to continue.

The current market is a perfect example of this situation. Yes, the S&P 500 has clearly broken out to the upside, but the bears have a great many complaints about the current action.

S&P 500 Daily
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However, the key is that there are some positive signs developing in the "oomph" category. That should not be taken the wrong way, this does not appear to be a runaway bull leg at the moment. People are not falling all over themselves to get into stocks here. However, there is one indicator with a very good long-term record that bears some attention.

Should Traders Trust the Thrust?

One of the best ways to judge the momentum in the market is via "thrust" indicators. In short, a trader should look for price, breadth, and/or volume to surge over a short period of time. Cutting to the chase, on Wednesday, there was a buy signal from a price-based "thrust" indicator.

Related: Does The S&P Have Anywhere To Move?

The indicator involves the price movement of the Value Line Composite index, which is intended to measure the broad market. First, take a three-day moving average of price. Next, calculate the 30-day average of price. Then, plot the standard deviation of the three-day relative to the 30-day.

When the standard deviation of the three-day average from the 30-day average exceeds 0.5, a buy signal is given. Conversely, when the standard deviation of the three-day to the 30-day is below -0.5, a sell signal is flashed. Anything in between is considered neutral.

As of the close on Tuesday, the standard deviation of the three-day to the 30-day moved up over 1.0 - thus a buy signal occurred. In short, this means that there has been some "oomph" behind the latest move.

The Stats Behind the Indicator

The good thing about this particular indicator is that it goes back to 1964. Granted, this is not a perfect indicator, as no indicator is truly perfect. However, it has been a pretty good indication of momentum in the market for a very long time.

According to Ned Davis Research, when this indicator is on a buy signal, the Value Line Composite has advanced at a rate of 20.6 percent per year. And given that since 3/10/1964 the the average buy-and-hold return of the Value Line has been 7.7 percent, this isn't bad.

When the indicator has been on a sell signal - meaning that there is some "oomph" to the downside happening - the Value Line has lost ground at an annualized rate of ten percent per year.

And when the indicator has been neutral, the Value Line has gained at a rate of 6.0 percent, which is less than the 7.7 percent long-term average.

The key takeaway here is that there is a very large spread between the returns when the indicator is positive, negative and neutral. As such, this is an indicator that may be worth paying attention to when it is either positive or negative.

Positions in stocks mentioned: SPY

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