Blast-Off Market Indicators

By Michael Cintolo, Chief Analyst, Cabot Growth Investor and Cabot Top Ten Trader
From Cabot Wealth Advisory 

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When it comes to market timing, I prefer to keep it simple, and that's exactly what my newsletters do. For the most part, my timing is based on two things—the trend of the overall market, and the action of leading stocks. One pertains to the overall market's health, while the other tracks the stocks I usually focus on. Simple.

However, there is one category of indicators that I do track...though they generally give signals only every few years! Thus, you can't use these indicators to tell you when to get in or out of the market, and they're unlikely to be much benefit in your daily investing routine.

So why follow them? Because when they do flash green lights, it tells you something unusual is happening—something unusually bullish!

I'm talking about blast-off indicators (I haven't thought of a snazzier name for them), and the concept revolves around a "super-overbought" market. Overbought is a term that refers to a market that's run-up for a few days in a row, and thus is commonly thought to have come too far, too fast. A pullback often ensues.

Most of the time, overbought-type indicators work pretty well for the overall market. (FYI: They generally work poorly for leading stocks.) Yet when a market gets EXTREMELY overbought, instead of signifying a market that's in need of a pullback, it's actually telling you there's a sudden, dramatic, powerful change in perception among investors...and such a change usually persists for months. 

These "super-overbought" readings have historically occurred near the start of major bull markets (hence the blast-off moniker). Instead of pulling back following these signals, the market either consolidated briefly, or simply pushed higher...and did so for many months! Thus, while blast-off indicators are rarely of use, when they do turn bullish, they are VERY useful.

One blast-off indicator I follow is the A-D Line ratio; specifically, if on average twice as many stocks advance as decline on the NYSE over a 10-day period, you've witnessed a rare surge of buying power. This indicator has signaled sustainable new bull markets lasting over a year in March 2009, January 1987, August 1982 and January 1975, among others.

Another rare blast-off signal tracks the percentage of all NYSE stocks that are trading above their 10-week moving average. Again, when the readings get up to 70% or 80%, the market is usually ready for a pullback.

But when the readings get up to 90%—that is, nine out of 10 stocks on the NYSE are trading above their respective 10-week moving averages—it signifies a kick-off of major proportions. On average, the S&P 500 was up about 15% six months after these signals. Most impressively, during the next nine months, corrections in the index have been limited to 5% in general. So not only were there hefty gains, but the ride was relatively smooth.

Long-term, these blast-off indicators will tell you when the odds are strongly in favor of higher prices in the months ahead. When they do, look to buy on weakness, be it individual stocks, or even exchange-traded funds (ETFs).

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