How to Read Stock Market Indicators
Each month, I’ll review the top stock market indicators to find out what story they have to tell. You can learn how to read these indicators, as well as many others, in my book, All About Market Indicators (McGraw-Hill).
The idea is to use a number of indicators, not just one, to determine which way the market is headed. In addition, use the indicators as an early warning signal rather than to time the market. A market can remain in dangerously overbought territory for weeks, months, and even years before reversing.
What the Stock Market is Telling Us Now
The following market indicators monitor the sentiment, or psychology, of the market. These are contrarian indicators, which means you should do the opposite of what everyone else is doing. For example, if the indicator shows that everyone is buying stocks, you should consider selling. Do not use sentiment indicators to time the market, but only to measure what the crowd is doing.
American Association of Individual Investors (AAII): When investors are too bullish (over 60%), it’s a sell signal. When they are too bearish, (over 50%), it’s a buy signal.
Signal: The week of February 27th, investors were 28.4% bullish and 36.6% bearish. This is a neutral signal.
Investor’s Intelligence Advisor Sentiment Survey (II): When independent newsletter writers are too bullish (over 50%), it’s a sell signal. When newsletter writers are too bearish (over 50%), it’s a buy signal.
Signal: The week of February 27th, newsletter writers were 46.3% bullish and 21.1% bearish. This is a neutral signal. On the other hand, it shows that the independent financial media is more bullish about the stock market than the public right now.
CBOE Put/Call Ratio: This indicator tracks the volume of put and call options that trade on the CBOE. Because so many retail option speculators are often wrong, it’s a clue to do the opposite.
If the Put/Call ration is lower than .75 (more call options are being bought), it’s a sell signal. If the Put/Call ratio is higher than 1.0 (more put options are being bought), it’s a buy signal.
Signal: As of March 1, the Put/Call ratio was .67, which is a sell signal, but not as strong as last month (.55). This means that more individuals are buying call options on individual stocks because they are bullish about the market.
Note: Trader and author Martin Zweig was the first to use the Put/Call Ratio to identify tops and bottoms by betting in the opposite direction. Sadly, Mr. Zweig passed away last week at the age of 70. He will be missed.
Note: The International Securities Exchange (ISEE) also has an indicator, the ISEE Call/Put Ratio, which is also very useful.
Moving Averages are my favorite technical indicator because it tells you when a market trend has begun or ended. Basically, it keeps you on the right side of a trend. The most popular, and useful, moving averages are the 50-, 100-, and 200-day MA.
Signal: The moving averages are telling us the long-term market trend is still positive, although we had a bit of a scare last week. Looking at the three-month chart, the S&P 500 index is above all three of its moving averages.
Note: Moving averages are not designed to catch tops or bottoms, and are sometimes slow to react. They also don’t work well in choppy markets.
COMMENTS ABOUT THE MARKET
According to the market indicators, the trend is still positive. However, because of economic concerns, it would not be surprising to see a short-term pullback.
In my newest article for MarketWatch (will be published in a week), I’ll be discussing ways of using options to protect yourself if you are bullish about the stock market. To help you sleep at night, you can use options to insure your stock portfolio.
In addition, author Amy Smith will discuss her next stock idea using the CAN SLIM investment system. The last stock that Smith mentioned, Lumber Liquidators (NYSE: LL), performed brilliantly. It fit the strategy of the long-term trader, which means you can hold stocks and mutual funds long term, but also trade.
When Smith mentioned LL in my MarketWatch column, it was trading at $58.93 per share. When earnings were released, it shot up to $65. After the one-day stock market plunge of 130 points, LL dropped all the way to $54. It’s now at $60.70 and climbing. This is definitely a stock you could hold for the long term, but also use for short-term trades.
If you want to learn more about stocks and options, you can read my book, Understanding Stocks(McGraw-Hill), or Understanding Options (McGraw-Hill).