Traders often focus on useless information. Thus, most traders wind up losing money in the market.
That’s no accident. It’s what they’re trained to do.
Mainstream media and other popular sources love to fixate on highly popular, but useless indicators. Moving averages, the Relative Strength Index, the MACD, volume bars, etc.
All of these indicators are incredibly popular. You can find them on any amateur trader’s chart setup. And that’s why they don’t work.
When everybody knows a piece of information, there’s no edge in it. There’s nothing in that information to tell you whether a trade will work or not.
Because when you don’t have edge, you’re not competing. And make no mistake, trading is a competition against every other trader in the market – from professionals who trade for a living, to someone opening a Robinhood account for the first time.
Especially as an option trader, you have to remember that you operate in a market dominated by professionals. If you are going to win, you have to break from what everybody else is doing.
Today, I’m giving a wake-up call. And I’ll share the one indicator most traders are too scared to use, but could point you to some of your most profitable trading decisions.
Be Honest With Yourself…
The 200-day moving average (MA) is a perfect example of an overused, useless indicator. I’ve seen it on thousands of charts. But it’s impossible to beat the market with it.
If you wait for stocks to cross above the 200-day MA before you buy, you will always get in late after the bull market begins. If you wait for stocks to cross below before you sell, you’ll already have lost substantially. You can’t get great returns when you miss the first 40% of the bull and sell 10% below the high.
Price-to-earnings (P/E) ratios are another example. These are useless for the same reason most technical indicators are. If everyone knows the information, it’s not worth knowing. It’s already factored into the stock price.
Lots of useless information, just like this, is readily available. You can find P/Es, MAs, and other popular indicators on dozens of websites.
Be honest with yourself…
If these indicators worked, would they be easy to find? Large funds would just trade on those signals and not spend millions on research.
The reason they spend so much on research is because they’re searching for an edge. Amber wrote about her process for finding an edge. I follow a similar process, but have developed some different ideas over the years…
The New Bull Market Indicator
I like to follow market breadth indicators. These measure participation in the market from individual stocks.
Breadth indicators include the percentage of stocks closing up for the day. Or the percentage of volume on trades executed at higher prices. There are indicators tracking new 52-week highs, new 52-week lows, and more.
In short, breadth indicators are versatile. They can tell you lots of different things about the market picture. And they’re especially effective at calling long-term bottoms.
Take a look at the chart below.
(Click here to view larger image.)
The blue bars in the middle of the chart are the percent of stocks closing higher for the day. Readings above 90% are topped in green.
The red bars at the bottom are the percent of up volume for the day. Readings over 90% would also be in green, but there are none.
And that’s the point of this chart. While we saw the number of stocks closing higher top 90% twice in the past two weeks, volume hasn’t confirmed. If it did, we would have a strong signal that the bear market has hit bottom.
At the bear market bottom in March 2020, for example, both values topped 90% on the same day.
(Click here to view larger image.)
That signal came on the very first day of the bull market.
We also saw this exact pattern in March 2009.
In fact, it’s found at almost all bear market bottoms since 1960 when breadth data became available.
Sometimes, we don’t get this precise signal. Instead of two indicators reaching 90% on the same day, we may see one at 90% with the second at 80% for two or three consecutive days. That can also mark a bottom.
Regardless, what this should show you is that breadth is a useful indicator – especially for right now.
Right now, breadth isn’t telling us the bear market is over. It will eventually. But 99% of investors won’t know it.
If you want to know the best time to buy stocks, ditch the common indicators and add some breadth measures to your chart setup. Once stocks do finally bottom, you’ll be glad you did.
Michael Carr, CMT, CFTe
Editor, True Options Masters