From the January 01, 2010 issue of Futures Magazine • Subscribe!

Trading indicators: A confidence game

1981 THROUGH 1990

There have been several distinct periods reflected in the CI. The first period encompassed the early years of the primary bull market from the early 1980s to late 1990 (see “Upward bound”). The CI relative to the S&P 500 had a generally upward bias to suggest that investors were relatively willing to take on risk and were generally optimistic. In addition, lesser-cycle intermediate-term peaks and valleys can also be identified using the slow stochastic indicator for both the S&P 500 and the CI.

The second general period in CI followed the October 1990 price lows in the stock market (see “Leading the recovery,” left). The CI not only led prices into the late 1990 correction, but the index remained in an erosive phase until late 1994 and as the market continued to work higher during that five-year period. And while the slow stochastic indicator on the monthly S&P chart remained in relatively overbought territory, the slow stochastic indicator applied to the CI fluctuated between modestly overbought and oversold readings. That tendency lasted until late 1994 when deeply oversold readings in both the S&P and the CI were followed by an upward spike in CI as market prices rallied to new all-time highs.

While investor confidence as reflected in the CI continued to do well into mid-1996, there was marked deterioration in CI as the market rallied into the 2000 price highs. Thereafter, there was steady deterioration coincident with the ensuing bear market that lasted into the late 2002, early 2003 lows.

In its third phase, the CI uptrend that lasted for nearly five years and until October 2007 peaked in early 2004 (see “Forecasting the fall,” left). But that peak, which was about halfway through the eventual stock price rally, was never surpassed. In fact, a massive divergence in the CI that preceded the 2007 highs suggested that investors were increasingly skeptical of the uptrend, just as was the case at the top of the tech boom back at the 2000 market highs. The eventual bear market low in CI (45.2) the week ending Dec. 19, 2008, was 54% below the statistical high of 98.7 reached the week ending Aug. 16, 1996.

CURRENT MARKET REVIEW

While the CI reached its nadir into the November 2008 market price lows with coincident oversold readings on both the intermediate and major cycles, in subsequent strength CI has failed to significantly overcome major resistance created by the 2002, early 2003 statistical lows in CI. That failure is in spite of S&P 500 index prices that are currently well above similar price levels (1091 vs. 768).

Clearly, the CI is reflecting less optimism about future market prospects than market prices, as some participants would have us believe. In addition, recent slow stochastics readings in both the S&P and the CI have moved back into overbought territory to suggest the possibility of market vulnerability as both data series have lost upside momentum in the vicinity of defined 200-day moving averages. A shorter-term concern reflects the fact that the CI peaked the week ending Aug. 7, 2009, at 71.1 and has yet to revisit that level despite strength to new intermediate-term highs by the market.

With finite amounts of data and an infinite number of potential indicators available, market analysts may be tempted to think that a more-indicators-is-better approach to analysis might be the best market strategy. But if two indicators can provide information, then will 20 indicators, each with its own performance variables, do an even better job?

Such an approach can create analytical nightmares. When an increasing number of indicators must be coincident before action can be taken, the end result can be slower and more cumbersome.

A better approach might be to use a variety of time-tested indicators on different data. The results can provide a better result than throwing multiple indicators at the same data for results that may yield little more than repetitive signals that can prove to be not only redundant, but even conflicting and confusing.

Experience shows that the Barron’s CI, when combined with a reputable indicator such as slow stochastics, can give the analyst market insights that can influence buy and sell decisions. In other words, if the Barron’s CI has begun to diverge from market price action, there is a possibility that the current trend may be nearing a turning point.

Toward the end of the fourth quarter of 2009, not only was the CI facing defined statistical resistance, but the slow stochastic indicator that monitors movement in the CI moved back into overbought territory and a zone of vulnerability. Coincident, upside, statistical extremes generated by the slow stochastic indicator using S&P 500 index monthly closing prices suggest investors could become less optimistic about the stock market into the first quarter of 2010, or at least until the stochastics on both data streams appear less vulnerable.

Robert McCurtain is a technical analyst, market timer, and private investor based in New York City. He can be reached at traderbob@nyc.rr.com.

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