New Feature: Weekly Market Internals
***I have made some updates to what I track to get a sense of there the market is at. There is a lot more detail coming. Stay tuned…this post will be updated shortly***
I have recently added a feature to the Robotic Investing site that I am calling Weekly Market Internals.
At the top of the home page, there will be two images that will be updated each weekend that will give you a read quick read of what the market is doing.
I personally look at two factors when evaluating how the market is performing.
The first factor I look at is market trend. This is simply whether the market is in an uptrend or a downtrend. My gauge for this is simply how the SPY is trading compared to its 200 day simple moving average.
If it is trading above the 200 day moving average, we are in an uptrend. Conversely, if SPY is trading below the 200 day moving average we are in a downtrend.
This is not rocket science, and is a well known trend indicator. Many of the strategies tracked on the site use this metric as an indicator of when to buy new positions or when not to. For example, the Stocks on the Move strategy does just that. If the SPY is above the 200 day line, then new positions can be purchased. If not, then stocks are sold according to the rules with the proceeds going to cash as opposed to buying the next best momentum stock.
Here is what the Market Trend on the SPY looks like at the time of this writing. As you can see, the market is way below the 200 day simple moving average and is definitely negative.
For Market Trend, I also use Guppy Charts to see what the shorter and longer term moving averages are doing.
When the market is ripping higher, all the moving averages will be heading higher, and the short-term ones will be above the longer-terms ones, with good separation between them.
For example, in the image below the August and September periods are showing an amazing market uptrend. The red and blue lines are heading higher and there is a lot of white space between the lowest red line and the highest blue line. You will also notice it starting to break down at the end of September as the red line converged and started to bump into the blue lines. That was a foreshadowing of the downtrend we see from October to January.
With these two charts combined, it is easy to see that the market is not in a good place, and caution should be used to protect capital. That can mean different things for different people. For me it means sitting on the sidelines waiting for the market to recover.
The second factor I use when increasing my situational awareness of the market is market breadth.
Market breadth is a way to gauge the direction of the overall market by analyzing the number of companies advancing relative to the number of companies declining.
If more companies are advancing than declining, that is a positive sign. If more companies are declining, then that is obviously a negative sign.
Market breadth can be examined on many time frames. Personally, I like to look at the number of stocks that are either up 20% or down 20% in the quarter. I calculate this every day, and determine the ratio between the two.
I use the quarter as the time frame to avoid whipsaws and because I am only trying to get a sense of the longer-term direction as opposed to day-to-day action.
A ratio over 1.0 is positive breadth and a ratio under 1.0 is negative. Here is what the chart looks like as of the writing of this post.
As you can see, breadth is still negative, but has been improving since the end of December. Once the blue line starts to trade above 1.0 in the Positive Market Breadth territory, then the market is in much better shape.
How to Use Market Internals
Market internals gives investors an overview of how the market is performing. Most importantly, it is not intended to be trading strategy on its own.
Many people confuse Market Internals with a trading strategy, in that it is way to maximize returns. That is incorrect.
Instead, Market Internals like trend and breadth are risk management tools. When the trend and breadth are both negative, it is prudent to be very cautious as an equity investor. The market has a tendency to continue to drop in these circumstance and it is hard to make money going long equities. Easing off your equity exposure and sitting more in cash can help reduce drawdowns and protect your capital.
In summary, Market Internals are a risk management tool to help you limit your equity exposure during times in the market when it is easy to see hug drawdowns. Look at what the trend and breadth numbers are doing. Are they flattening out after going up for an extended period of time? Or are they low and heading lower. Having that situational awareness of what the market is doing is critical and these tools have helped me to do just that.