Market Indicators 

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Market Indicators

Market indicators are used to determine the direction of the markets. Many technicians gauge the short- and intermediate-term directions of the market by looking at the following indicators:
* Daily volume
* Breadth of the market
* New highs and lows

Daily Volume

As mentioned at the beginning of this chapter, technicians consider volume and price movements to be indicators of supply and demand. When the daily volume on the New York Stock Exchange (NYSE) increases and stock prices rise, the market is considered to be in a bullish trend (it has more buyers than sellers). In a bear market, volume increases and prices decrease because of increased selling. Thus, in a weak market, prices might increase while volume declines. When both prices and volume decline, this is a somewhat optimistic sign that owners of stock are reluctant to sell. Statisticians might differ considerably in their interpretations of price and volume combinations. Technicians can interpret even the more straightforward high volume differently. Some view this difference positively, and others see it negatively (Dorfman, 1993, p. C18). In practical terms, daily price and volume changes might be difficult to correlate to determine a trend in the market. Information about trading volume at the end of each trading day can be obtained using the Internet or in financial newspapers.

Breadth of the Market

The breadth of the market is a measure of the number of advancing and declining stocks to indicate the upward or downward direction of the market. By examining the numbers of stocks that have advanced, declined, and remained the same on a particular day of trading, analysts believe that they can determine the relative strength or weakness of the market. If the number of stocks advancing in price on any particular day exceeds the number of stocks declining in price, it is considered to be a strong market.

For example, of the 3,425 issues traded on the NYSE on October 6, 2006, 1,208 advanced, 2,058 declined, and 159 remain unchanged; these numbers presented a negative picture of the NYSE for that day. In other words, for every 20 stocks that declined in price, 12 stocks increased in price. Astrong picture of the market is presented by a greater number of advancing stocks over declining stocks, which is a favorable sign indicating a rising market. The opposite is true when breadth is negative: A greater number of declining stocks over advancing stocks indicates a falling market.

The financial newspapers list these daily statistics for the markets, and many technicians use these data to calculate the advance/ decline indicator. The advance/decline indicator is the cumulative total of the daily advancing stocks minus the total number of daily declining stocks. You calculate this indicator by subtracting the number of declining issues from the advancing issues and then dividing this difference by the total number of issues traded for the day. For example, assume the following trading information for the NYSE for the week:

Plotting the cumulative difference on a daily basis results in the advance/decline line, which is used to indicate the trend of the market. A declining advance/decline line indicates a falling market, and an increasing advance/decline line indicates a bullish market. When the advance/decline line is going up and the market is falling, this is a bullish short-term signal for the market; when the advance/decline line is falling and the market is going up, this is a bearish signal. No research consistently shows the predictive capabilities of the advance/decline line. Two more complex indexes are based on the advance/decline indicator: the ARMS index and the trading index.

New Highs and Lows

Many technicians monitor the daily new highs and new lows on the NYSE. When a sizable number of stocks reach their 52-week highs and they outnumber the stocks that reach their 52-week lows, and this pattern is maintained over time, technical analysts are bullish on the market.

Many technical analysts place importance on the signals given by volume, market breadth, and the new highs and lows. However, these signals are not foolproof, and possibly technical analysts place too much importance on their predictive capability for future market activity.

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