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TUESDAY a.m.
November 26, 2002
The Sentiment Dashboard
by David Nichols
Today we're unveiling a graphic that hopefully will make it easier for you to know what the markets are doing.
We're calling this the "sentiment dashboard", and it will now be included at the end of every Morning Briefing. This dashboard is meant to be a quick and easy way to gauge whether the market is in an uptrend or a downtrend, and to also give as much fine-grained detail about the trend as possible. Hopefully, we can accomplish this with a minimum of confusion.
Distilling this down was a tougher job than we thought, so I'd like to thank my colleague Adam Oliensis, Editor of The Agile Trader, for really jumping into this project, and figuring out every nuance. Most of the credit goes to Adam on executing this project.
I'm not expecting everybody to understand the dashboard right away, as there is actually a lot of information to process. But over the next few weeks I'll continue to go over it in detail, and going forward I'll always include some comments about it. It won't take long to know it well, I think.
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The two big gauges show the trend in the mid-term, measured in days, and the long-term, measured in weeks. We chose these two time-frames because this is the way most people view the market -- in moves that last weeks to months. Only short-term traders are interested in the quicker market oscillations, and while we do track these with obsessive detail, it's not always helpful for the longer term view.
Each gauge is divided into two sides. On the left is the uptrend half, with the arrow green if the market is in an uptrend. There is also an acceleration arrow, showing the strength of the trend's most recent movement, and a number -- in this case 5 -- in the middle box. This number varies between 0 and 7, and shows the confidence in the current trend reading. 7 is maximum confidence, and 0 is no confidence.
The current mid-term gauge shows an uptrend that is reaching its final stages. This is why I've been warning that it will soon be time to take profits. The arrow is reaching the very end of the uptrend, and is now in a position to flip over into a downtrend. But it hasn't done it yet, and the confidence in the uptrend is still high at 5. We should see this number decrease towards 0 before the trend flips over into a downtrend. Deterioration in this number -- with the gauge so near the end of the uptrend -- will be a strong hint to take profits on the uptrend.
When the arrow does moves over into a downtrend, then it will be time to consider going short, when the confidence in the reading moves up far enough. If you're a more aggressive trader, you can try a position when the confidence is only 1 or 2, with more cautious (sensible?) traders waiting for a higher reading of 3 or higher.
I'd like to note that we purposely designed this mid-term gauge to correspond with the trading of the leveraged Rydex Funds that we do in the Morning Briefing. So we'll be initiating positions in these funds at the early stages of a trend, and taking profits at the end of the trend. Having this graphic depiction of the market action will help all of us -- me included -- become more disciplined about entering and exiting these positions. And if we're disciplined about this process, then there's not a whole lot that can go wrong.
Also note that in this instance, short positions are going to be tough going until the long-term gauge also flips over into a downtrend. It's possible to make money going against the long-term, but you're definitely swimming upstream. When the two gauges are in sync -- as they have been since the October bottom -- the gains are easier to obtain.
The tank in the middle shows how much "sentiment fuel" is available to drive the markets. Right now the tank is at 48%. We've included the path to the current reading because it's important to know whether the tank is emptying (during an uptrend), or filling up (during a downtrend).
Remember, sentiment is a contrary indicator. A surplus of negativity equates to a full tank of gas for the markets, and represents a lot of potential energy to push prices higher. At the bottom in October, the tank was 100% full, indicating lots of fuel for the current uptrend, which has indeed pushed the markets up for a remarkable 7 straight weeks.
If the markets were now to rise further on a surge of bullish euphoria, then the tank could theoretically be drained down to zero. This would be an amazing signal to go short, right when the trend gauge flipped over to a downtrend. But there is still plenty of sentiment fuel in the tank to push the markets higher, which is one reason why playing the short side lately has been a tough proposition.
If this is confusing, again, don't worry. I'll keep explaining this until it's second nature. Also, since your 21st Century Alert subscription includes Adam's Agile Trader service, you can also read about the dashboard there.
I'd like to thank the subscribers that have given us feedback about the dashboard, from Adam's introduction yesterday. We've quickly incorporated some of the suggestions into the design, and it's nicely improved. So thank you!
Bull markets and Bear markets
Bull markets are great. The gains are easy. The economy is humming along, and growth is everywhere. People are friendlier. Food tastes better.
But we certainly don't need a new bull market to make money. If it happens, that's great! But if it doesn't, there's no need to worry. Our sentiment analysis -- and our new sentiment dashboard -- work extremely well in a bear market.
In a bear market, the trading gets thinner, as more and more of the liquidity is sucked out of the stock market, fleeing for safer havens. It becomes easier to play the sentiment of the remaining players in the market, as there is more potential for the market to squeeze them onto one side or another. When there is a strong imbalance of sentiment, we take the other side of the trade, and wait for the money to flow our way.
In a bull market, liquidity starts to flood in from many different places: foreign money, money from bonds and money market funds, allocations from retirement accounts, etc. It puts a firm bid underneath the market, and lifts all boats. There is less potential for a squeeze in one direction or another -- although this effect is always there.
We've spent a lot of time figuring out how our dashboard works during bull markets and bear markets, so we can plan our trading accordingly. We should continue to do well no matter what the market does going forward.
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