During a time when all eyes are on computerized trading andterms like Stocastics, waves, Fibbanacci numbers and R factors arebeing hurled about, most investors are overlooking the simplemarket indicators that have worked for years. One such indicatoris the New York Stock Exchange Bullish Percent, created byChartcraft in 1955. Where most investors go wrong is not knowingwhen to sell. We look at the market like a football game. Thereis a time to have the offensive team on the field (buy stocks) anda time to have the defensive time on the field (sell or hedgestocks). The NYSE Bullish Percent Index can be instrumental inhelping investors gauge the prevailing risk in the market place. Understanding which team to have on the field (offensive ordefensive) is the key to risk management. Put another way, riskperception is the key to risk management. Mike Burke, editor ofInvestor Intelligence, extended this investment approach to includelarge industry sectors which we follow very closely. We use theindex the same way as we would us it in determining the relativeoverbought - oversold nature of the market in general. In thisreport we are using the Bullish Percent theory on the largeindustry sectors underlying the broad averages.
The NYSE Bullish Percent has been one of the best at callingintermediate market tops and bottoms since it's inception in 1955.It is based on the percent of stocks on the NYSE that have bullishpoint and figure charts. If there are 2,000 stocks on the NYSE and600 of those stocks have buy signals on their point and figurecharts and 1,900 have sell signals, then the NYSE Bullish Percentis at 30 percent. In the case of an industry sector if there are100 stocks in the sector and 30 are on buy signals the SectorBullish Percent would be at 30%.
A stock is considered bullish if its last signal was a buy(the last columns of X's - demand - exceeds a previous column ofX's). A stock is considered bearish if the last signal was a sell(the last column of O's - supply - exceeds a previous column ofO's).
When the majority of stocks are giving buy signals, it is asign that the sector is supporting higher prices, and on thereverse, if the majority of stocks are giving sell signals it is asign that the sector is no longer supporting stock prices. This isespecially true when the Dow Jones is making new highs and theSector Bullish Percent is in a clear decline. The best sellsignals are given when the Bullish Percent rises above the 70percent level and reverses down 6 percent to below the 70 percentlevel. The Bullish Percent is a leading indicator so the Dow willtypically continue rising after many of the Sector BullishPercent's have reversed. The best buy signals are given when theindex declines below the 30 percent level and reverses up 6 percentto above the 30 percent level. In many cases the truth liessomewhere in between. When sell signals are given, it suggeststhat not enough stocks are participating to keep the uptrend inmotion. When buy signals are given more stocks are changing fromnegative to positive chart configurations. This suggests that somesort of sector bottom has been reached and the probability ishigher prices for the sector. This index was the late EarlBlumenthal's sole market indicator.
SIX BASIC RISK LEVELS
1. BULL CONFIRMED SECTOR: The strongest of conditions andone that should be played heavily on the upside. Here we wouldwant to aggressively purchase the underlying common stocks in thissector. This type of market occurs when the Bullish Percent givesa buy signal by exceeding a previous column of X's, as illustratedabove or rises above the 50 percent level. Rising above the 50%level simply suggests that since more stocks are on buy signalsthan are on sell signals, the probability is higher prices for thissector. Single buy signals on the trend chart of common stocks canbe followed.
2. BULL ALERT SECTOR: Takes place when the Bullish Percentrises more than 6 percent from beneath the 30 percent level toabove that critical level, but not to exceed a previous top or the50% level. At this stage many stocks are making their lows, butthis reversal to the upside suggests that most lows have been madeand the probability is higher prices from there. A long tradingposture should be established here but with caution. Tradingprofits of 10 to 15 percent should be taken as many stocks willhave a tendency to retest their lows before an extended bull trendis established. Stocks giving sell signals should be avoided Thesame action happens at tops: stocks have a tendency to retesttheir highs before an extended bear trend is established.
3. BULL CORRECTION SECTOR: Suggests that the bull trend inthis sector is going into a period of correction but the trend islikely to resume shortly. It is characterized by a 6 percentreversal down from a bull confirmed status but taking place belowthe 70% level. This change in risk is telling us that the marketleaders will likely drop in price due to profit taking. Defensiveoption strategies can be taken at this point. Selling call optionsor purchasing puts as insurance against a potential decline in theSector might be a desired strategy at this point. Traders shouldbe prepared to buy common stock on the next 6 percent reversal tothe upside in the Bullish Percent Index. The bull market in thissector is still intact, it's just taking a breather.
4. BEAR CONFIRMED SECTOR: Characterized by the BullishPercent Index penetrating a previous bottom as illustrated above ordeclining below the 50 percent level. Declining below the 50%level simply suggests that since more stocks are on sell signalsthan on buy signals the probability is lower prices. We neversecond guess this risk level. Traders can establish short positionsin some of the stocks in the sector. All other long stock positionsshould be hedged using the options markets.
5. BEAR ALERT SECTOR: Occurs when the Bullish Percent dropsbelow 70 percent without penetrating a previous bottom. When thishappens it suggests that the market is in a corrective phase. These corrections usually bring the Bullish Percent down to the 50percent level or so. A 6 percent reversal back up in the columnsof X's will put the sector back in a bull confirmed status. In thebear alert market, defensive action should be taken using theoptions market for hedging purposes. Short positions can beestablished in some of the common stocks underlying the sector. Atraders approach should be taken at this risk level. Shortpositions should be liquidated on the next 6 percent reversal tothe upside in this index. Investors must be nimble because themarket will eventually revert back to bull confirmed or slip intobear confirmed status. If the market slips into bear confirmedstatus, the short positions should be held and should proveextremely profitable. If the Bullish Percent reverts back to bullconfirmed status, the short positions should be liquidated and moreemphasis placed on trading the upside with the strong stocks in thesector.
6. BEAR CORRECTION SECTOR: A pause in a bear trend withinthe sector. Here stocks will retrace some of their decline. Thisphase is characterized by a 6% reversal up from a bear confirmedstatus above the 30% level. The only action taken here is simplyto hedge existing short positions for the duration of thecorrection. Typically the bear trend will resume in the near term.
Mike Burke, editor of Investors Intelligence compares themovement of the Bullish Percent to the tactical strategies of afootball game. In a football game there is a time to have theoffensive team on the field and a time to bring out the defensiveteam. Investing is very similar and need not be more complicated. When the sector is supporting higher prices as evidenced by theBullish Percent rising in a column of X's, it is time for theinvestor to score points. When the Bullish Percent reverses intoa column of O's and begins to decline it is time for the investorto stop trying to score and to place more emphasis on keeping thesector from scoring against him. The Bullish Percent Index willhelp investors know when to play offense and when to play defense. The Sector Bullish Percent simply illustrates the prevailing riskin that particular group of stocks. Within the confines of a bullor bear market, sectors continually rotate. They come in and outof season like vegetables in a supermarket. The idea is to selectthe sectors for purchase as they come in season not out. Wetypically don't buy Asparagus in January, it is very expensive and rather tasteless compared tothat which is available in July. The Bullish Percent Index is yourCOACH, follow his advice and you will have superior results.