An Indicator That Helps Identify When to Buy Stocks
Imagine getting this call…
It’s from the business editor of the Herald Sun.
He says this to you: ‘We’re running a share tipping competition. Can we publish your name, photo, and 10 stock selections for the next four weeks?’
Would you jump at the chance, or politely decline?
Well, I was once in that exact situation.
You see, my old business partner and I had a fledging stock advisory business. And we’d sent the business editor our promotional material in the hope of getting some publicity.
To our amazement, it worked — he gave us a call a few days later.
Needless to say, we took the opportunity on the spot. The prospect of appearing in a major newspaper was irresistible. This was our chance to show people what we could do.
I remember one journo commenting at the time. He said predicting stocks over such a short period is like reading tea leaves. His view was that it was more a game of luck than skill.
But I disagree…
While market timing is always uncertain, stock selection doesn’t need to be a lottery. There are tools and tactics you can use to swing the odds in your favour.
A prime example is buying into strength. This strategy helps get you on the right side of the market. Your chances of success are often better when you trade with the trend.
Having an idea of market cycles also helps. While this won’t give your timing GPS accuracy, an understanding of bullish and bearish phases is a real advantage.
So how did the tipping competition go?
Well, we did OK. Our first appearance was a win. The editor then asked us back for the end of year final. We won that, too. This got us a regular spot on the panel for the next few years.
Timing the market is never precise — there’s always an element of chance.
But as I said, there are ways to put the odds in your favour.
How does the indicator work?
I’d like to tell you what the All Ordinaries will do next. But I can’t. There’s no special formula to pinpoint the market’s every move. Trading is uncertain by nature.
But there are ways to gauge where things stand.
In a moment, I’m going to give you an update on an indicator I use. I call it the ‘Quant 300’, and it helps me identify where the market is within the bull and bear cycle.
Let me refresh you on how it works.
I designed the indicator myself. I use it to identify if the market is overbought or oversold. It does this by calculating the number of stocks that meet my bullish criteria.
The indicator analyses the top 300 companies. These stocks change over time, but the number remains fixed. This allows me to compare readings for different periods.
There are two rules to determine if a stock is bullish — it must be above the 100-day moving average and have hit a 40-day high. It then stays bullish until the shares fall below the moving average.
Check this out:
I last showed you this indicator two months ago.
At the time I said:
‘You’ll see the indicator is currently below the previous peaks and edging higher. This is typically a positive environment for stocks.’
As we know, this wasn’t the case — the market was on the cusp of a correction. The green circle on the chart marks the time I made my comment.
Now, you may think the indicator got this wrong.
But it didn’t. It was my analysis that was off the mark.
You see, I discounted a key piece of information…
While the indicator was indeed rising, it hadn’t hit an oversold level since the previous peak. This meant the upward swing in the indicator was potentially less reliable.
That’s forecasting for you. You’re bound to slip-up at some point.
But that brings us to the present…
Look where the indicator is now. It’s showing one of the lowest readings in years. These are the sort of conditions that often set the stage for a big advance.
The Quant 300 can help indicate when to buy
The key is to identify when to buy. And I believe the indicator can help with that.
Have a look at this:
Let me explain what’s going on.
The bottom chart is the Quant 300 dating back to 2009. As I said earlier, it shows the number of stocks that meet my bullish criteria. This figure typically ranges between 25 and 225.
A graph of the All Ordinaries sits above the indicator.
The next thing to note are the green lines. These represent the lows for the Quant 300. I’ve marked where the number of bullish stocks fall below 50, and then rebound back above 50.
Now this is where you need to study the chart closely.
Follow each green line up to the All Ordinaries chart. What do you notice?
I’ll tell you what I see.
In most instances, a reading below 50 leads to a multi-month rally. A number of these have been major turning points. Others have resulted in strong bull market extensions.
An exception was in mid-2015. The market began to turn higher, but then fell back.
There are still plenty of bearish voices talking about worse to come. While this is always possible, I still believe that the chances of a big bear market are low at this time.
The Quant 300 is yet to signal a turn in the market — the trigger for that will be when the indicator breaks back above 50. But my view is that a lasting low is near.
Quant Trader doesn’t use this indicator. It’s merely something I developed to help gauge market conditions. I also find it’s interesting to look at data in different ways.
Hopefully this helps bring some perspective to the bearish voices.
Until next week,
Editor, Quant Trader
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