What to Look at When the Charts Aren’t Saying Anything

Yesterday stocks generally rose as U.S. investors looked forward to the Q1 earnings season, which began after the close with the usual release of earnings from Alcoa (NYSE:AA). This was in contrast to lower European markets, which felt the brunt of Germany and France’s pressure on other eurozone members to get their houses in order amid rumors that the eurozone may be dissolving.

U.S. markets traded within a narrow zone due to an absence of news, but the Dow Jones Industrial Average rose 33 points to 12,393, the S&P 500 gained 3 points at 1,281, and the Nasdaq advanced 2 points to close at 2,677. The Big Board traded 721 million shares and the Nasdaq crossed 475 million. On both exchanges breadth favored advancers by about 1.5-to-1.

Since there was little in the way of new technical developments yesterday, I’ll take this opportunity to discuss other forms of technical analysis than charts despite their importance in determining the primary and secondary direction of markets.

The two types of indicators generally used by technicians are “internal indicators” and “sentiment indicators” sometimes called “contrarian indicators.” Examples of internal indicators that we use are MACD, stochastic, momentum and relative strength index (RSI).

The sentiment indicators are considered contrarian because the gauge investor emotions, which are usually wrong. Most investors, no matter how rational, usually buy at the top and sell at the bottom. This is due to either being afraid of “missing the boat” or fearful of further losses. This herd mentality is called market sentiment. Thus, when market sentiment is high, most believe the market will head higher, and when sentiment is low, the majority feel that the market will head lower.

Therefore, professional traders and institutional investors focus on the extremes of public sentiment in order to gauge the best time to enter or exit markets. The indicators that they use most are the CBOE Volatility Index (VIX), the put/call ratio, mutual fund money flows, and the AAII Sentiment Survey.

The CBOE Volatility Index (VIX) is often called the “fear index” and is released in real time by the Chicago Board Options Exchange. It is based on the number of puts and calls outstanding, and when low it is considered to be complacent (bullish), and when high it is considered to be showing fear (bearish). Further explanation of the VIX is available here.

The put/call ratio is calculated by taking the ratio of the volume of puts over the trading volume of calls. Thus, low investor sentiment occurs when there are a large number of puts versus calls. The put/call ratio may be found here.

Mutual fund money flows are often reviewed to determine the direction of “dumb” money. The study is published by the Investment Company Institute and updated weekly. In the past five weeks, the data shows money flowing from mutual funds with increases in bond funds and cash — a bullish indication.

As for the AAII Sentiment Indicator, we’ve covered this in detail in the past. The survey is published weekly and can be found here.

Stock charts are used by technicians as a primary source for determining the market’s direction, however, the study of the secondary sources — indicators, both internal and sentiment — often provides support for the charts’ direction and sometimes gives a hint of future change.

Conclusion:  Overall the sentiment indicators favor a neutral to upside bias and support the view that in the intermediate term stocks should take a mildly bullish route but not break to new highs until fall.

And if you are looking for profitable option trades, you may want to check out my colleague Joe Burns.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

Article printed from InvestorPlace Media, https://investorplace.com/2012/01/daily-stock-market-news-what-to-look-at-when-the-charts-are-not-saying-anything/.

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