Computerized Investing Market Dashboard Overview
“Don’t fight the tape.” This is a phrase often used in finance that means we shouldn’t bet against the trend in the market. As investors, even the best analysis of a given security can be trumped by short- and long-term trends in the market. While it’s common to find prognosticators flouting market timing systems that called the last market top or bottom, it’s very uncommon to find anyone who has been able to time the market correctly and consistently over a long period of time. That being said, it is useful to gauge the direction of the market to make tactical investment decisions. The CI Market Dashboard is intended to do just this. We have brought together several market timing indicators that, when viewed in their entirety, should help you get an idea of the current trend of the market.
The indicators we are using for the Market Dashboard are as follows:
- iShares Dow Jones U.S. Index Fund (IYY) 100-day Moving Average Crossover
- MACD on the iShares Dow Jones U.S. Index Fund (IYY)
- NYSE New Highs/New Lows
- Percentage of NYSE stocks reaching new highs
- Percentage of NYSE stocks above 50-day moving average
- NYSE Bullish Percentage Point & Figure
- NASDAQ Summation Index moving average crossover with MACD confirmation
- AAII Investor Sentiment Bullish Percentage
- Shiller CAPE
Each week will we update the data on each of these indicators and provide you with our take on the current direction in the market.
iShares Dow Jones U.S. Index Fund (IYY) 100-day Moving Average Crossover
The IYY is an ETF tracking the performance of the Dow Jones U.S. Index and holds roughly 1,300 stocks. The Dow Jones U.S. Index is designed to represent approximately 95% of the investable U.S. stock market and is a market-cap-weighted index. Since it is a market-cap-weighted index, its performance is dominated by the largest stocks traded on U.S. exchanges. However, it offers broader market exposure than the S&P 500 Large Cap Index or the Dow Jones industrial average. In addition, our analysis indicates that the Dow Jones U.S. Index is slightly more responsive to changes in market direction relative to other indexes.
Moving averages are the simplest trend indicators. When deciding on the number of periods to use when calculating a moving average, there is a balancing act between timeliness and usefulness. The fewer number of periods you use, the more responsive the moving average is to changing trends. This, in turn, produces better profits in both bull and bear markets. All else equal, IYY closing prices above the moving average line indicate a upward bullish, trend, while IYY closing prices below the moving average line indicate a downward, bearish trend.
However, the downside of using a more responsive moving average, with fewer periods in the calculation, is the greater potential for “whipsaws.” A whipsaw occurs when a security's price heads in one direction, but then is followed quickly by a movement in the opposite direction. If your moving average is too responsive, it may generate back-to-back buy/sell signals based in this short-term price movement. Whipsaws are especially common when the market is moving within a trading range (moving sideways). When this happens, moving averages tend to flatten out, increasing the likelihood that the price can close above or below the moving average line in short succession. Acting on these buy and sell signals can result in a string of unprofitable trades and higher trading costs. It is for this reason that we don’t rely on only a moving average as in indicator of the market’s direction.
A bullish signal is generated when the closing price of IYY rises above the 100-day moving average. A bearish signal is generated when the IYY closing price crosses below the moving average.
MACD on iShares Dow Jones U.S. Index Fund (IYY)
The moving average convergence/ divergence (MACD) is a trend-following indicator developed by Gerald Appel. It is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA (periods can be days, weeks, months, etc.). Exponential moving averages place greater weighting on more recent prices, making them more reactive to recent price moves than simple moving averages, which place equal weighting on each periodic price.
This indicator also consists of a “signal line,” which is a nine-period moving average of the MACD. The indicator generates buy and sell signals when the MACD line crosses the signal line: A crossover from below is a buy and a crossover from above is a sell.
Since the MACD makes use of moving averages, like the IYY moving average crossover indicator, it is sometimes prone to generating false short-term signals. This again highlights the importance of using multiple indicators when determining when to buy and sell.
Beyond using crossovers between the signal line and MACD to identify possible buy and sell points, traders also look for divergences between the direction of the MACD and the underlying security or index. When you see the MACD making new highs while the underlying security or index is falling, this points to a possible reversal in the index or security.
A bullish signal is generated when the MACD line crosses above the signal line; a bearish signal is generated when the MACD line crosses below the signal line. On those rare occasions where the MACD line and signal line are basically equal, the indicator is neutral.
NYSE New Highs/New Lows
The NYSE High Highs/New Lows indicator ($NYHL) is the difference between the number of daily new highs and the number of new daily lows for the stocks traded on the New York Stock Exchange (NYSE). An increase from extremely negative readings is a possible indication of a market reversal to the upside.
A bullish signal is generated when the $NYHL falls to -750 or lower and then begins to increase. Alternatively, if the $NYHL declines by 750 points or more from a reading above zero and then begins to increase, this too is a bullish signal. Otherwise, the indicator is neutral. The indicator will also move from a bullish signal to a neutral signal if no new bullish signals are generated in the six months following an initial bullish signal.
Percentage of NYSE stocks reaching new highs
One drawback of the NYSE New Highs/New Lows indicator is that a reversal from an extremely positive number is not a reliable indicator of possible market reversal to the downside. An alternative is to look at the percentage of NYSE stocks hitting a new high each week. When this percentage reaches extreme high levels and then begins to fall, this is an indication that a market top has been reached.
This indicator is bearish when the percentage of NYSE stocks reaching new highs is 25% or greater but is declining. When the indicator is below 25% or above 25% and still rising, it is neutral. Once a bearish signal is generated, that signal will remain in effect for six months unless a confirming signal in the same (or opposite) direction is generated, at which point the date will be reset. If no confirming bearish signal is generated over the following six months after an initial bearish signal is generated, the indicator will revert back to neutral.
Percentage of NYSE Stocks Above 50-day Moving Average
Extreme overbought or oversold conditions in the market are often precursors to a reversal. When a large percentage of stocks are trading above their 50-day moving average, this can indicate an overbought condition, with an increased chance of a market reversal to the downside. Alternatively, when a small percentage of stocks are trading above their 50-day moving average, this potentially oversold condition may signal an upcoming reversal to the upside.
The indicator is bullish when the percentage drops to 25% or lower and then begins to rise. Likewise, a bearish signal occurs when the percentage reaches 75% or above and then begins to decline. The indicator is neutral when neither of these conditions is being met; the percentage is below 25% and falling; the percentage is above 75% and rising; or the indicator is between 25% and 75% without a recent reversal from extreme levels. Once a bullish or bearish signal is generated, that signal will remain in effect for six months, unless a confirming signal in the same (or opposite) direction is generated, at which point the date will be reset. If no new signal is generated over the following six months after a signal is generated, the indicator will revert back to neutral.
NYSE Bullish Percentage Point & Figure
The NYSE bullish percentage (NYSBP) indicator tallies the number of NYSE stocks whose point & figure charts are currently indicating a buy signal and expresses the number as a percentage of all NYSE stocks. When this percentage reaches extremely high levels and begins to decline, the market may be headed for a reversal to the downside. Likewise, when this percentage begins to rise from extremely low levels, the market may be forming a bottom and preparing to reverse to the upside.
A bullish signal is generated when the bullish percentage falls to 30% or below and starts to turn upward. A bearish signal is generated when the percentage peaks above 70% and begins to turn downward. The indicator is neutral if neither of these conditions is met; the indicator is below 30% and falling; above 70% and is rising; or the indicator is between 30% and 70% without a recent reversal from extreme levels. Once a bullish or bearish signal is generated (or if a signal in the opposite direction is generated), that signal will remain in effect for six months, unless a confirming signal in the same direction is generated, at which point the date will be reset. If no new signal is generated over the following six months after a signal is generated, the indicator will revert back to neutral.
NASDAQ Summation Index Moving Average Crossover with MACD Confirmation
The NASDAQ summation index (NASI) consists of two parts. The first is the difference between the number of advancing stocks and the number of declining stocks in the NASDAQ composite index. The second is the five-day exponential moving average (EMA) of the summation (NASI) line. When the NASI line crosses above the EMA, this is considered a buy signal, while a crossover to the downside is a sell signal. Adding a MACD of IYY can serve as a confirmation of the crossover buy and sell signals on the NASI. A NASI buy signal is confirmed when the MACD line crosses above its signal line; likewise a NASI sell signal is confirmed when the MACD crosses below its signal line.
Furthermore, when both the NASI and MACD are showing positive divergence with the NASDAQ composite—reaching new highs while the index is declining—this can be viewed as a strong buy signal. Likewise, negative divergence with both indicators is considered a strong sell signal.
A bullish signal is generated when the NASI rises above its five-day EMA and is confirmed by the MACD crossing above its signal line on or near the same day. A bearish signal is generated when the index falls below the five-day EMA and the MACD has a confirming sell signal on or near the same day. If neither of these conditions is being met, the indicator is neutral.
AAII Investor Sentiment Survey Bullish Percentage
Investor sentiment is often used as a contrarian indicator—individual investors tend to be most bearish at market bottoms and most bullish at market tops.
One sentiment indicator that is widely followed by professional traders and the financial press is AAII's Investor Sentiment Survey. Each week, AAII members can vote online as to where they think the market is going over the next six months—up (bullish), down (bearish), or sideways (neutral). The results are published each Thursday at the AAII website (www.aaii.com/sentimentsurvey).
A bullish signal is generated when the percentage bullish reading drops to 25% and then rises the next week; a bearish signal is generated when the percentage bullish reading rises to 50% and then drops the following week. If neither of these conditions is being met, the indicator is neutral. In addition, if no new confirming signal is generated within six months after a bullish or bearish signal is generated, or if a signal is the opposite direction is not generated within six months after a bullish or bearish signal is generated, the indicator will revert back to neutral.
The Shiller CAPE comes from Nobel Laureate Robert Shiller, the Sterling Professor of Economics at Yale University. CAPE is short for cyclically adjusted price-earnings ratio. It is cyclically adjusted in the sense that the earnings used in the calculation are averaged over a longer interval of time; Shiller uses 10 years. Shiller's research shows that real price divided by the 10-year average of earnings does actually help predict the stock market. The numerator of the CAPE is the real "inflation-adjusted" price level of the S&P 500 index.
Shiller believes that the stock market is somewhat predictable, but he admits that the CAPE ratio does not predict what is going to happen next year very well. Unlike the other indicators used in the CI Market Dashboard, which are short-term in nature, the CAPE is a long-term indicator. The CAPE predicts what will happen over the next five or 10 years. In other words, when prices are high relative to 10-year average earnings, then that suggests that prices will come down, but you don't know exactly when. You might have to wait five years or 10 years for them to come down. For patient long-term investors, the CAPE is an indicator of value.
For the purpose of our market dashboard, a bearish signal is generated when the CAPE rises to 100% or more than its historical median or midpoint value. A bullish signal is generated when the CAPE falls 50% or more below the historical median. The indicator is neutral when neither of these conditions is being met. In addition, if no new confirming signal is generated within six months after a bullish or bearish signal is generated, or if a signal is the opposite direction is not generated within six months of a bullish or bearish signal is generated, the indicator will revert back to neutral.