Oct

Our Timing Indicator Says the Stock Market is Topping Out

We have long used the $BPNDX as a medium-term market timing indicator.

The $BPNDX is an oscillator that shows the percent of NASDAQ 100 stocks with current Bullish Point and Figure Charts. The legend goes that when you get a white candle under 30 (on the weekly chart), it is a buy signal and when you get a red candle over 70, it indicates a sell signal on the Q’s.

In theory the BPNDX is an oscillator that can move between 0 and 100, however it’s rarely stretched below 20 or over 80. What we look for is a long-range candle to indicate a potential market reversal, though the signal is not necessarily confirmed on the first instance. As a matter of fact we started getting nervous somewhat before the peak in 2007, only to watch the market push higher temporarily.

Let’s look at a chart of the QQQQ over the same time frame. Notice how the 3rd red candle over 70 coincided almost exactly with the top, and subsequently the QQQQ lost 1/2 it’s value. Now look at where we closed the week as of October 24th 2009.

My thinking now is that the first big red candle over 70 is the heads-up, the second one reminds you that the market could roll over at any point, and the last time we saw the THIRD big red candle, the market collapsed.

Not to read too much into this, but notice how right now we are getting red candles while $BPNDX is over 80. That is not a good omen and indicates that the top in market might already be in. If anything this indicator should make any trader or investor take a step back and realize that preservation of capital might be key going forward.

Notice how the last white candle under 30 coincided with the March Low in the market.

Notice the extreme reading of 1 last year coincided with last October’s market bottom.

We can still trade individual stocks to the long side, however it is wise going forward to take profits faster, say at Target1, rather than holding out for a large move. It might be time to get defensive and keep position sizes smaller than normal. On days when the losers far outnumber the winners it might be best to stay on the sidelines. We don’t want to overtrade when conditions indicate there might be rough sailing ahead.

If you study these charts and ponder the “white candle under 30, red candle over 70″ signals, you will see that there may indeed be some cause for concern going forward.

“While a market collapse is not likely probable, it is always entirely possible”. Invest accordingly.

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