A Look Back at the S&P with a Breadth Indicator

I've been tracking many market indicators by recording different market data over the years and one technique that has worked well is a market breadth indicator that consists of new highs that are made in the stock market. Daily, I record the new highs of several markets and then average them and multiply the numbers to get a "multiplier number" that I have used as an indicator for the broad stock market. As you can see from the chart below, the TLT New High Multiplier gave a warning signal far in advance from the major market decline of 2008. Here's a chart that compares the indicator line to the S&P etf SPY.
As you can see from the above chart, the new highs multiplier number was printing lower and lower highs between February 2007 and November 2007. This was a clear sign that something was not right. Furthermore, the new highs have stayed at much lower levels since September of 2007. What this tells me is that we will need to start seeing higher highs on the new highs multiplier index to confirm a reversal. Right now we're just moving sideways in a very bearish pattern (which could possibly mean that we're close to a bottom).

The important thing to remember when using this kind of data is that the first divergence (or signal in opposite direction) is not necessarily a valid warning signal, but recurring moves that are higher or lower can indicate that a change of trend is coming. The frustrating aspect about these types of signals is that just because the trend might be changing doesn't necessarily mean that the trend will not continue for a little while after the initial divergences. This is where technical analysis becomes more of an art than a hard science and it's up to us traders to determine when the risk/reward ratio is not worth trading because of such divergences.

The above chart clearly shows the risk of staying long long the S&P in mid to late 2008 and updating it regularly might shed some insight into when it's a good time to reverse and go long. Only time will tell...I'll make sure to post an updated chart in the future.

Good luck out there.

TLT