Stock Market (Share Bazaar) and futures traders used to live like two separate tribes. They traded different markets and used different analytic tools. The wall between them began to crumble after stock index futures were created in 1982. Both tribes rushed to trade them. An astute trader owes it to himself to master the tools of both tribes.
Shrewd stock traders use Stochastic, moving averages, and other tools of futures analysts. Futures and options traders can time their stock index trades better by using stock market indicators. They include the New High-New Low Index (probably the best leading indicator of the stock market), the Traders’ Index (TRIN), and several others.
How to Construct NH-NL
The New High-New Low Index (NH-NL) tracks the numbers of market leaders. It measures the number of stocks that have reached new highs or lows for the year on any given day. The stocks on the list of new highs are the leaders in strength, and the stocks on the list of new lows are the leaders in weakness. NH-NL confirms trends when it rallies or falls in gear with prices. It identifies tops and bottoms in the stock market when it diverges from prices.
The New High-New Low Index measures daily differences between new highs and new lows. The New High-New Low Index is easy to calculate by hand, using information from the Market Diary section of most major newspapers.
NH-NL = New Highs – New Lows
New highs and new lows are reported by most data services in the United States. Make sure that your data vendor calculates new highs and lows over a 52-week period. Some use the ancient “calendar method” and calculate new highs and lows going back only to January.
Plot the New High-New Low Index as a histogram, with a horizontal reference line at zero level. On the days when there are more new highs than new lows, NH-NL is positive and plotted above the centerline. On the days when there are more new lows than new highs, NH-NL is negative and plotted below the centerline. If the numbers of new highs and new lows are equal, NH-NL is zero.
Crowd Psychology
A stock appears on the list of new highs when it is the strongest it has been in a year. This shows that a herd of eager bulls is chasing its shares. A stock appears on the list of new lows when it is the weakest it has been in a year. This shows that a crowd of aggressive bears is dumping its shares.
The New High-New Low Index tracks the strongest and the weakest stocks on the exchange and compares their numbers. It measures the balance of power between the leaders in strength and the leaders in weakness. This is why NH-NL is a leading indicator of the stock market. The broad indexes, such as the S&P 500, tend to follow the trend of NH-NL.
You can visualize the 2000 stocks on the New York Stock Exchange as a regiment of 2000 men. If each stock is a soldier, then new highs and new lows are the officers. New highs are the officers who lead the attack up a hill, and new lows are the officers who are deserting and running downhill. There are no bad soldiers, only bad officers, say the military experts. The New High-New Low Index shows whether more officers lead the attack uphill or run downhill.
When NH-NL rises above its centerline, it shows that bullish leadership is stronger. When NH-NL falls below its centerline, it shows that bearish leadership is stronger. If the market rallies to a new high and NH-NL rises to a new peak, it shows that bullish leadership is growing and the uptrend is likely to continue
Stocks making new highs for the year are the leaders in strength, and stocks making new lows are the leaders in weakness. NH-NL measures the direction and intensity of market leadership by comparing the number of new highs and new lows.
In the summer of 1987, mass bullishness rose to a high pitch, as the bull market roared into its final peak. It was safe to hold stocks as long as each new high in the stock market was confirmed by a new peak in the New High-New Low Index (A, B, C, D, and E). The August peak in the stock market was accompanied by a bearish divergence (E-F) in the NH- NL Index, giving a sell signal.
When the stock market declined in September, many traders went bargain hunting. Five years of rising prices had trained them to use declines for buying. NH-NL, meanwhile, pointed to a severe weakness. It peaked out at only 100 (C), indicating weakness. NH-NL turned negative in October (H). It gave repeated sell signals in advance of the historic crash.
If the market rallies but NH-NL shrinks, it shows that the uptrend is in trouble. A regiment whose officers are deserting is likely to turn and run.
A new low in NH-NL shows that the downtrend is likely to persist. If officers are running faster than men, the regiment is likely to be routed. If stocks fall but NH-NL turns up, it shows that officers are no longer running.
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