The Best Internal Market Indicator EVER!
Thursday, April 2, 2009 | Bob De DeaThis chart is the most closely followed BPI there is. But before we get to this granddaddy of all indicators, I need to talk a bit about what a BPI chart is, how it’s calculated, and what it’s good for.
Do you remember last week, in Part 2 of my P&F Primer, when we talked about P&F buy and sell signals? Say you were able to take all of the P&F charts for 3,000 stocks and make one P&F chart that showed how many of those securities were on P&F buy signals and how many were on P&F sell signals. (You’d do so by dividing the number on P&F buy signals by 3,000. This would give you the percentage of stocks on P&F buy signals. Since a P&F chart is always on either a buy or a sell signal, the remainder would be on P&F sell signals.) You would have a pretty good picture of the past and present market. If you then applied P&F chart principles to this master chart – the three-box reversal rule, trend lines, support and resistance – you would have a killer tool for determining internal market breadth. (Here I am indebted to Chris Rowe for his distinction between the external market -- Dow-Jones, S&P, broadcast and print media coverage, etc. -- and the internal market.)
Behold the Bullish Percent Index chart for the New York Stock Exchange!
The x-axis is like a standard P&F chart, tracking the time, while the y-axis (both on the left and right) is the percentage scale. Notice the BPI is charted using a 2% box size.
The last “X” (circled in red) represents the current position of the NYSE BPI and tells us that 43.55% of stocks are on P&F buy signals (with 56.45% on P&F sell signals). Generally speaking – it depends on the chart you’re looking at (more in a minute) – when the level drops below 30% the market is considered oversold. Conversely, when it rises above 70% it’s considered overbought. You can see that the NYSE BPI dipped below 30% in 2001-2002, not again until early 2008, then since late 2008 it dipped below three times (October, November and February-March of this year). A 10% level is considered extremely oversold. In October and again in November 2008 the NYSE sunk below 10%, a level not seen in at least ten years. If it isn’t yet obvious, by giving us a snapshot of the historical highs and lows, the NYSE BPI gives us a peek into the prevailing level of risk behind the current market.
Here is the secret behind the power of the BPI: With a three-box reversal, over 6% (3 x 2% per box) of all the stocks of the index must change direction for the BPI to register that change. With a 3,000-stock index, that’s 180 stocks. This is a significant amount of movement in an index.
To reiterate, when the NYSE column changes from X’s to O’s, it requires a shift in around 180 stocks from a P&F buy signal to a P&F sell signal (SUPPLY takes control). When a column changes from O’s to X’s, it requires a shift in 180 stocks from a P&F sell signal to a P&F buy signal (DEMAND takes control).
Taking the above two facts together, we can ascertain the following:
- When a BPI falls below 30% and then reverses up by at least 6%, this is typically a strong buy signal.
- When the BPI rises above 70% and then reverses down by at least 6%, this is typically a strong sell signal.
I say “typically” because different market conditions elicit different investor reactions, making the picture more (or less) volatile, more (or less) consistent, etc.
In addition to the 30% and 70% level “gauges”, you can also identify support and resistance levels as you would on a P&F chart (support below in green, resistance in dark red).
We can see that as of today (I'm writing this on Monday, March 30th), the NYSE has risen to its last point of resistance (around 44%). [Note: In fact, at the close on Monday it had bounced off this resistance, falling to 40.94%. Since, however, it wasn’t a three-box reversal downward, the chart did not change.]
I always start any trading day by looking at the NYSE BPI to see where we are and to check any change in the long-term trend, or the approach to any support or resistance levels that I’ve identified. Often a simple glance will inform the kind of play I make that day. If, for example, the trend is downward, but the column reverses to X’s, I’ll give that change less weight than if it were a change in the direction of the trend – in this example of a downward trend, if there were a reversal from a series of X’s to O’s. In other words, I’d treat the first as an intermediate (or in this market, even as a short-term) trend and trade appropriately. (I personally tend to trade the extreme levels unless range trading.)
It’s worthwhile to take a moment to ruminate on the differences between a standard P&F chart and a BPI P&F chart:
(I put that last one in there to emphasize that history is always important!)
Regarding points 2 and 4, think about it: A BPI is a chart of P&F signals; it makes little sense to look for a standard P&F buy or sell signal as a clue (it’s sort of like the dog eating its own tail). But if it takes 6% to make a change in column on the BPI, the column change can be seen as the buy or sell signal. (Volatility, and therefore risk, can be easily seen: Study the number of column changes in a year in the charts above. In 2003 there were two; in 2008, thirteen.) By the way, Teeka calls the predictive power of the NYSE BPI "incredibly impressive".
So far we’ve only been talking about the NYSE BPI. But since a Bullish Percent Index is a pictorial representation of the underlying stocks that are on a P&F buy signals, it can be calculated for any group of stocks. (In full disclosure, in addition to a P&F chart it can also be represented as, for example, a line chart.) There are BPIs for the S&P 500, the Dow-Jones 30, the Wilshire 5000 (and many more indices), and for the nine major sectors of the S&P 500.
Now we’ve got a basis from which to examine sectors and indices more in depth.
The ETF Master Trader program and Sector Hunter both use sector BPIs and a proprietary method to find much more refined entry points than we’ve discussed here.
For more about P&F charts, there's bunches o'books out there. Try looking online or at your local library. In the meantime, Happy 2Q 2009!
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Bob De Dea
Guest Contributor
The Tycoon Report
