Using the Summation Index to Pick Bottoms

Bottoms, however, are a bit easier to identify using the Summation Index, and take a shorter time frame to develop. Let 's look at how the McClellan Summation Index can pick out bottoms in the NYSE. Figure 6.7 shows the NYSE and its McClellan Oscillator and Summation Index dating back to 1996. This chart illustrates what the levels at which the McClellan Summation Index bottoms out to pick lows in the NYSE.

Since 1996, the NYSE has reached a bottom at the same time that the Summation Index gone down to just below —500. This has occurred nine times since 1996. In this time frame, the NYSE reached a bottom three times when the Summation Index fell to below —2,000. Therefore, when the NYSE McClellan Summation Index goes below —500, a trader

NYSE McClellan Oscillamr (traditional) 1996 Presen!_t<j 2007 DejlsionPmnjcom

HYSE Composile Inde* S42S57 »28,01 +03« OC/Q7

NYSE McClellan Oscillamr (traditional) 1996 Presen!_t<j 2007 DejlsionPmnjcom

HYSE Composile Inde* S42S57 »28,01 +03« OC/Q7

i W7 -iros isw 2000 2001 2002 2003 2C04 200s 2coe 2007

FIGURE 6.7 Summation Index Setups for Picking Bottoms in NYSE from 1996 through Q1 2007

Source: Chart courtesy of DecisionPoint.com.

i W7 -iros isw 2000 2001 2002 2003 2C04 200s 2coe 2007

FIGURE 6.7 Summation Index Setups for Picking Bottoms in NYSE from 1996 through Q1 2007

Source: Chart courtesy of DecisionPoint.com.

would be advised to start looking for a low. It's not a bottom, however, until the Summation Index turns up from below —500. Therefore, if the Summation Index keeps going down below —500, then the trend in the market is still downward. The Summation Index could go as low as — 750 or lower before it turns up.

Notice in Figure 6.8 the May 2004 time frame when the NYSE Summation index fell to nearly —1,500 before turning up. The NYSE did bottom

FIGURE 6.8 Summation Index Shows Drop to Nearly -1,500 in May 2004 and a Retest of That Low Again in August 2004 Source: Chart courtesy of DecisionPoint.com.

out when the Summation Index was near the —1,500 level, but the market did test that low again in August 2004 as the Summation Index made a much higher low. This condition showed that the August 2004 low was stronger because more issues were carrying the rally off that low compared to the May low.

To pick a bottom in the NYSE with the Summation Index, the first condition is that the index must be at an extremely oversold level of — 500 or lower to indicate capitulation in the market. As Figure 6.9 shows, no signal is generated until the Summation Index turns up from below — 500. Once the Summation Index turns back up from below —500, this shows that the advance/decline line is now improving, and more issues are starting to carry the rally. This is a bullish condition. As you can see, this process of picking bottoms using the NYSE Summation Index is much easier and quicker than identifying tops with the Summation Index.

VOLUME ANALYSIS

After breadth analysis, the second step in determining "the wind at your back" is volume analysis. Remembering, all three analyses—breadth, volume, and momentum, must line up in the same direction in order to have the wind at your back and reduce your risk for putting your money in the market.

In Chapters 3 , 4 and 5, we covered volume analysis for equities in detail. Now we will cover volume analysis for the indexes, which is similar to the process we used for equities. In previous chapters, I stressed that volume is the force behind stocks. The same applies to the indexes. Volume pushes the indexes up or down, and the market goes in the direction of the legs with the highest volume.

Because we are dealing with the longer-term time frame of trends that last three to six months, weekly charts of the indexes provide the best picture for this time frame. I have also found that the S&P 500 SPDRs (SPY) and PowerShares QQQ Trust (QQQQ) for the Nasdaq Global Market have higher volume differences than the S&P 500 (SPX) and Nasdaq Composite (COMPQ), and therefore are easier to identify energy directional changes. Our volume studies of the indexes will be use SPY and QQQQ to represent the S&P 500 and Nasdaq Composite.

Tops form in markets because energy to the upside has run out. Volume is energy; therefore, when a market hits new highs and volume shrinks, the rally is doomed to fail. To do volume comparisons, we look at previous weekly highs in the market and compare volume as those highs are being tested. On the test, we look to see if volume is equal to or greater than the volume of the previous high to determine if the rally has

FIGURE 6.9 Buy Signals Are Triggered when the Summation Index Turns Up from Below -500

Source: Chart courtesy of DecisionPoint.com.

FIGURE 6.9 Buy Signals Are Triggered when the Summation Index Turns Up from Below -500

Source: Chart courtesy of DecisionPoint.com.

energy to pass through the highs, or if volume is at least 10 percent less, which means the highs will be rejected. This can be seen most clearly using longer time frames and weekly charts.

Figure 6.10 is a weekly chart of SPY from December 2003 through August 2004. Notice that as SPY tested the January 30, 2004, high, it did

FIGURE 6.10 Volume Analysis of SPY Shows Volume Decline as January 30, 2004, High Is Tested in February and March Source: Chart courtesy of DecisionPoint.com.

not have enough energy (volume) to get through that level. That high was rejected twice and triggered sell signals in the week of February 20 and March 5. The decline finally started the week of March 12.

Let's examine the Ord-Volume method for the same time frame for SPY. In Figure 6.11- look at the first down leg from the 116.5 level in late January 2004. Volume on this down leg came in at 56 million, which is a 75 percent increase in energy from the previous up leg that had volume of 32 million. This condition shows that downside energy is starting to take control and is a bearish sign.

The next up leg has volume of 33 million, which is a 41 percent decline in energy compared to the volume for the previous down leg of 56 million. This shows that the downward energy is still in control. For a rally phase to continue, the up leg should have more energy than the down leg, and in this case the opposite is occurring. SPY rallies to a new high at 116.97, but with no expansion in Ord-Volume, which comes in at 34 million and 23 percent less than the previous down leg. This effectively

FIGURE 6.11 First Down Leg from 116.5 in SPY Shows a 75 Percent Increase in Volume Compared with Previous Up Leg—a Bearish Sign

kills the rally attempt. On the next leg down, Ord-Volume expands to 52 million, which has 53 percent more energy than the previous up leg. This big expansion in Ord-Volume shows a decline is under way.

Indexes do not have volume contractions and expansions that are as pronounced as what we see in equities. Therefore, we compare volume using bigger time frames to determine what the energy of the up leg and down leg energy is indicating, and to see if there is evidence that an index is nearing a high or low. The shift in energy from down to up or up to down can be seen easily seen in the Ord-Volume format for the current SPY example.

Let's look at what the NYSE McClellan Oscillator was saying for this same time frame. In Figure 6.12 , we can see that the first step of the Summation Index sell signal setup occurred when the second high in the Summation Index was lower than the first high, while the NYSE was making a higher high. (I have labeled these events as "1" and "2" in Figure 6.12.) As explained earlier in the chapter, these conditions showed that fewer issues were carrying the market higher and a bearish breadth divergence existed.

FIGURE 6.12 McClellan Oscillator for NYSE Examines Corresponding Time Frame for Bearish Setup in SPY as Shown in Figure 6.11 Source: Chart courtesy of DecisionPoint.com.

The next step of the sell signal setup using the McClellan Oscillator was when the second low of the Summation Index traded below the first low, which showed downside momentum in advance/decline line. (I have labeled this event as "3" in Figure 6.10). The last step was when the Summation Index turned down again and a sell signal was triggered. These events came right at the high and help to confirm the sell signal using the volume methods explained in Figures 6.10 and 6.11.

MOMENTUM ANALYSIS

Now let's take a look at momentum indicators in this same time frame to see how this analysis also helps to identify tops. In Chapter 2 ' I gave a brief description of a momentum indicator, explaining that it smooths out price fluctuations of an issue so it is easier to see what direction price is moving. When a momentum indicator is rising, that issue is in an uptrend, and when the momentum indicator is declining, that issue is in a downtrend.

Was this article helpful?

0 0

Post a comment