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Predict Stock Market Tops and Bottoms With The NH-NL Ratio
The New High/New Low (NH-NL) ratio has been around for many years, but different investors use this indicator in different ways. Some investors plot the ratio of positive numbers equal to new highs greater than new lows over new lows and negative numbers equal to new lows greater than new highs over a specified period of time, using the ratio as a neutral designation on the chart. I have developed and used the NH-NL ratio in a completely different way from some popular methods. I started following stocks making new highs while reading the Investor’s Business Daily paper several years ago. I didn’t use the news high as an indicator but I just studied the stocks to buy from the list. As I became a more experienced investor, I began to subconsciously gauge the market while new highs were rising or falling. After the stock market bubble burst in 2000, I began recording the difference between daily new highs and daily new lows. I will enter them into an excel sheet along with the price and volume of the major market indices and study their correlation. Within two years, I was convinced that major market tops and bottoms could be easily identified by aggressively studying the price and volume of major indices and studying the fluctuations of the NH-NL ratio. Common market indicators often give investors wrong moves in all directions and many market services and investors have developed new indicators to help evaluate the market and show turning points without great success. Many of these secondary indicators are successful in showing investors whether the market is weak or strong, but they fail to pinpoint the strength or weakness of a turning point with great accuracy. Many of these secondary indicators give false signals along with general market indicators.
With several years of serious study under my belt using my method of the NH-NL ratio, I have correctly protected my money during downturns and correctly directed my purchases when the market reversed and started a new sustained up-trend (not the head. fake).
How do I use my NH-NL ratio?
I start by recording daily new highs and new lows from Investor Business Daily (my preference) but you can use any free or paid service on the web. Over the past five years, I have developed key levels that the market must reach or breach to trigger certain actions. I have not pulled any of these numbers out of thin air as they are all based on real experience and not derived from back testing. For the market to follow me and convince me that it is starting a new up-trend, it must present me with a minimum of 500 new highs per day on a consistent basis. When a week ends, I add the weekly NH-NL totals and divide by the number of active trading days to get the weekly average. To consider risking more than 50% of my cash on new positions (new leaders) I have to average a minimum of 500 stocks per day. Once the weekly average reaches 800-1,000+ stocks per day, we know the market is in full rally and you can start committing your entire trading stake and using margin. In 2003, the market gave several instances when new highs were reached above 1,000-1,200 stocks per day, a very impressive amount. When the market shows such strength, the trend is clear and you have to make your money work for you by following the trend. Keep in mind that 75% of all listed stocks will follow the general trend of the market.
As recently as September and October of 2005, the NH-NL ratio has been negative, meaning we are seeing more new lows than new highs. When this kind of action happens, you should lock in profits and move your cash to the sidelines. It is not safe to invest in the long side of the market when the ratio is negative. Often, a bear market occurs when the ratio is weak and negative. If the market confirms a bear market or a down-trend, it may be an opportune time to short stocks or use advanced strategies with options (I recommend this only for advanced and experienced traders). You must determine if the market is in a down trend or trading sideways. If it is trading sideways, it would be better to pull your cash to the sideline and wait for the direction to form (either up or down). This article was written and published on October 25, 2005, the first day that the NH-NL ratio turned positive after 13 consecutive days of negative ratios. The average negative ratio of the past two weeks reached 15 quality new high stocks in just a few days. This kind of weak action could signal a bottom in the market as we prepare for a new rally. The most important indicator to watch in the next few weeks will be the NH-NL ratio to see if it continues to gain strength and may rise to new highs by 500 or more stocks per day. If this happens, the current signal of a rally in the major indices will be confirmed and you can start working on new leaders of more than 50% of your trading stakes as the stock moves up from sound bases or established support areas.
As I look back at the archived hard copies of IBD, I can see the strengths and weaknesses this ratio gave us in 2002 and 2003. I remember how the ratio went from negative territory in September of 2002 to positive ratio in October. 2002. After reaching positive territory, the ratio rose to a new high in the 800-1,100 range in the first six months of 2003 as we were in a strong bull market, the strongest year since the bubble burst. I don’t know what the next month or next year holds for investors, but you can get a good idea by tracking this indicator as it returns to the positive side after a very weak October (2005). I once wrote about the Halloween indicator and now I am convinced that it has some validity, especially if the NH-NL ratio confirms another rally heading into late October.
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