Bi-Weekly Stock Barometer No. 173

A buy signal looms - are you daring enough to step in?

Welcome to the biweekly stock barometer. This article comes out every 2 weeks and gives our big picture view of the market. If you're interested in following our signals and learning more about our system, then I invite you to click here and subscribe to the daily service - since the market can turn on a dime and so too can our interpretation as the market gives its daily clues to the future. Or sign up for our free weekly newsletter, where we provide up to date articles from our various trading services.

First of all, I wanted to say Happy New Year, although not so happy for the markets. But I think that's about to change. We'll take a look at that as we review our indicators below.

Also as an FYI, our annual forecast came out 2 weeks ago with all our reversals for 2008. Friday was the most recent date and I think that'll mark a low (+/- 2 days). So look for a turnaround at least by this Tuesday. My 2008 forecast only goes out to subscribers. So if you're interested in giving it a look, you can click the link above and sign up for a free trial.

Today, let's take a look at how to utilize the DSB 'Spread Indicators' in your own trading.

Each day, we feature Spread Indicators for the Nasdaq 100 (QQQQ), Gold (GLD), USDollar (DXY), Bonds (TLT) and Oil (USO). Spread Indicators monitor the momentum of these ETFs. We utilize them to develop our overall outlook for the market and also for some trading signals. Here's how you can use them to set up trades.

The spread indicators are algorithms that measure at the 'spread' between various short, intermediate and longer term moving averages - designed to correlate to the DSB. You'll note that each Spread Chart has two lines. A short term spread (yellow and dotted black line) and an intermediate term spread.

For the most part, the market will follow one or the other of the time frames covered by these indicators. It's impossible to know which one it will follow (only possible in hindsight). And it is important to understand that as a momentum indicator, a stock can keep moving, but its momentum can slow and give a sell signal before the move lower. From that perspective, you can consider the short term indicator an early warning and the longer term indicator more for confirmation.

The market operates in fractals within several time frames over the course of a year. For example, when the market goes through a short term consolidation, where the top and the bottom of the current trading range can be reached in 2-3 days, this is not the most ideal market for mid term traders and momentum indicators, unless calculated on a very short term basis - almost intra day - are not the best indicator to use in these markets. No matter - because if you diversify and trade more than one uncorrelated index, you should be able to find profitable movement somewhere.

The next important component of the Spread Charts is the zero level, which is marked on each chart. Consider it the balance point between strength and weakness. For example, a spread indicator may give a short term sell signal above zero, which would suggest consolidation in an uptrend - unless the spread indicator moves below zero. That's when the sell mode should gain price traction (or efficiency).

So we give more weight to a sell signal below zero, just as you'd give more weight to a buy signal above zero. You also want to look for extremes - i.e. when the indicator is at an extreme or relative high level, then you know it's going to reverse. The key there would be to look for a chart or technical reversal parameter in order to set up your sell signal - or if you're already long and just looking to sell, if you have a decent profit, there's nothing wrong with selling at that point.

Now let's take a look at our various spread indicators and what they're saying (beyond our normal comments).

QQQQ Spread - Not to be confused with the signals from our stock barometer, these give a big picture view on what the market is doing, when it's reached an extremely oversold level or when it's overbought. The short term QQQQ spread is at an extreme low and just reversing higher - this is our first sign of a bottom. The intermediate term is also moving lower and below zero.

GOLD Spread -Another line in our Gold Spread Charts is the leading indicator. When this line changes direction, it suggests gold will change direction. It's projected into the future and something we monitor. The Gold spread is at an extreme high on a short and intermediate term basis. We expect gold to reverse sharply relatively soon. If not a sharp reversal, at least a consolidation. This chart is featured at the bottom of this article.

USD Spread - The strength and weakness of the US Dollar can have a huge impact on the US Economy as well as other markets such as gold and oil. There are currency ETFs and Dollar ETFs that move inline and inverse to the dollar that can be utilized for further diversity.

Bond Spread - Bonds are to be paid attention to when you're trading financial markets since the bond market is roughly 10 times the size of the stock market. So when money flows into bonds, it is likely to impact stocks in a negative way. And vice versa, when money flows out of bonds, it has to go somewhere, and that tends to benefit stocks. The bond spread has been in sell mode for a few days and bonds are following lower.

OIL Spread - Oil also has a significant impact over financial markets which is why we monitor it. The Oil spread indicator (also featured at the end of this article) has been in sell mode and has crossed below zero, suggesting that the sell off should continue.

So how can you use these indicators? I'd suggest maintaining positions in all 4 ETFs, the QQQQ, GLD, TLT, and USO to create a diverse uncorrelated portfolio. Follow the short and intermediate term signals to leg into and out of positions. This will allow you to participate in profits when certain markets are not moving. Since they're ETFs, you can invest more per position because your position risk is much lower and you can also use margin to increase your position size.

How else can you use them? Well, I'll leave that up to you. I know many people subscribe to get these charts on a daily basis or to get our technical charts as well.

On to the charts.

Message From The Markets

Market action is ruled by sentiment and by monitoring market internals and studying sentiment you can reasonably predict future market movements. The basis of the Stock Barometer system is overlaying extremes in sentiment with sound technical analysis to predict the likelihood of future price movement. Each indicator and chart measures the hope, fear and greed of investors and traders from different angles. Follow along with my charts and over time, you'll also learn to understand how to read the markets, which is essential prior to setting up each and every trade.

STOCK BAROMETER CHART

The Daily Stock Barometer is a proprietary measure of market energy. The direction of the stock barometer determines our short-term outlook on the market's direction. A BUY or SELL signal is triggered when the indicator clearly changes direction. If the line is moving up, we are in BUY MODE and if it's moving down, we are in SELL MODE. The black line is a 5-day moving average that we use to confirm changes in direction. We may wait for the QQQQs to break support or resistance before changing mode.

EQUITY PUT CALL RATIO CHART

The CBOE put/call ratio is comprised of two sets of data; equity options and index options. The index component contains items that are used as a hedge, thereby distorting the correlation and interpretation of the indicator. I use the equity put/call ratio. This is one of the most accurate read of investor's fear and complacency.

TRIN/ARMS CHART

Richard Arms developed the arms index. It is also referred to the Trading Index or TRIN for short. It is a measure of the ratio of up stocks and down stocks divided by the ratio of up volume and down volume. Our Spread Chart converts the arms index data into momentum Buy and Sell Signals.

TICK CHART

The tick index is represents the sum of all stocks ticking higher minus all stocks ticking lower (a stock is said to be trading on an up tick when it trades at a higher price than the last sale). It's utilized as a day trading tool as it gives you an up to the second read of the intensity of buying and selling.

BREADTH (ADVANCE - DECLINE) CHART

Each day several thousand stocks either advance, decline or remain unchanged. The number of advances and declines normally ranges from +2500 to -2500. A high number of advancing stocks normally marks a top just as a high number of declining stocks normally marks a bottom. Monitoring the 5 and 13-day moving averages of this allows us to better predict future prices.

VXO CHART

The VIX is a measure of volatility on options pricing. We use the old VIX, which is now called the VXO. The higher the volatility, the more likely the market is close to a bottom, as traders are willing to pay more premium for puts, which act as Insurance on their long positions.

Cycle Time

Monday will be day 6 in our DOWN cycle.

The Stock Barometer signals tend to follow a 5, 8 and 13 and sometimes 21 day Fibonacci cycle that balance with 'normal' market cycles. Knowing where you are in the current market cycle is important in deciding how long you expect to maintain a position.

Potential Cycle Reversal Dates

2008 Potential Reversal Dates: 1/11, 2/1, 2/13. We publish these dates up to 2 months in advance.

If you look at our chart of the QQQQs, you can see our key reversal dates and how they could play out over the next month or so.

My timing work is based on numerous cycles and has resulted in the above potential reversal dates. They're predictive and have nothing to do with the barometer cycle times. However, due to their accuracy in the past, I post the dates here.

2007 Potential Reversal Dates: 1/10, 1/14, 1/27, 1/31, 2/3, 2/17, 3/10, 3/24, 4/21, 5/6, 6/15, 8/29, 10/19, 11/29, 12/13, 12/24, 12/31.

2006 potential reversal dates: 1/16, 1/30, 2/25, 3/19, 4/8, 5/8, 5/19, 6/6(20), 7/24, 8/20, 8/29, 9/15, 10/11, 11/28.

2005 Potential reversal dates based on 'other' cycle work were: 12/27/04, 1/25/05, 2/16, 3/4, 3/14, 3/29, 4/5, 4/19, 5/2, 6/3, 6/10, 7/13, 7/28, 8/12, 8/30-31, 9/22, 10/4, 11/15, 11/20, 12/16.

Stock Barometer Buy And Sell Signals

QQQQ or SPY Chart: A chart is provided in every bi-weekly report and shows the barometer Buy and Sell Signals (which are provided in my morning updates) as well as showing the next highlighted 'reversal' window. The numbers adjacent to the buy and sell signals are the number of days between signal (cycle time).

Here's one years of our end-of-day buy and sell signals for the Stock Barometer over the past year. They're marked on the QQQQ chart with red and blue lines (or red and blue arrows). Note we recently changed bottom and top to read buy and sell.

The following work is based on my spread/momentum indicators for the QQQQ, GLD, USD, USO and TLT. They are tuned to deliver signals in line with the Stock Barometer and we use them only in determining our overall outlook for the market and for pinpointing market reversals. The level, direction, and position to the zero line are keys in these indicators. For example, direction determines mode and a buy signal 'above zero' is more bullish than a buy signal 'below zero'.

Gold Spread Indicator (AMEX:GLD)

To trade Gold, utilize the Gold ETF AMEX:GLD. This gives us a general gage to the overall health of the US Economy and the markets, as well as to assists us in the entry of positions in our stock trading service.

US Dollar Index Spread Indicator (INDEX:DXY)

To trade the US Dollar, I'd utilize the Power Shares AMEX:UUP: US Dollar Index Bullish Fund and AMEX:UDN: US Dollar Index Bearish Fund.

Bonds Spread Indicator (AMEX:TLT)

To trade Bonds, I recommend Lehman's 20 year ETF AMEX:TLT. Note that the direction of bonds can have an impact on the stock market. Normally, as bonds go down, stocks will go up and as bonds go up, stocks will go down.

OIL Spread Indicator (AMEX:USO)

To trade OIL, utilize AMEX:USO, the OIL ETF. We look at the price of oil as its level and direction can have an impact on the stock market.

Summary & Outlook

The barometer remains in SELL Mode and we expect the markets to bottom early next week and advance into the end of the month.

Gold will join Oil and bonds in reversing lower as the dollar continues to find support and rally.

As always, if you have any questions or comments, feel free to email me here at jay@stockbarometer.com.

Regards,