Is this Market Top?
Tolik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Famed trader William O'Neil profiled in Jack Schwager's "Market Wizards" series of books shares the following indicators to identify a market top:
1. Average moves to a new high, but on a low volume
2. Volume surges for several days, but there is no progress on price
3. Leading stocks break down
4. Fed raises rates 2 or 3 times in a row
5. Advance decline line flails to penetrate prior highs, while averages reach new peaks
Let's examine the current market using O'Neil's indicators by looking at the S&P 500 index.
1. S&P 500 index is currently at a 5 year high with a volume slightly below 4B shares. Last year's top was reached at above 5B volume. Relatively speaking, this indicator seems to be indicating at least an intermediary top, flashing red for the bulls and green for the bears.
2. According to O'Neil, this indicator is another way markets usually top, and it could be used instead of #1. Since volumes seem to be dropping and prices are grinding higher, this indicator does not apply.
3. This indicator's reliability largely depends on the definition of a 'leading stock'. I can a offer a short list here, which is purely subjective: Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG), amazon (NASDAQ: AMZN) and Coke (NYSE: KO) all outperformed the index in the last 5 years. Apple (NASDAQ: AAPL) is more than 30% off its peak, but both goog and amzn are hovering around their all time highs, ko is lower than its peak but not by much. This indicator is very mixed, and may be interpreted in various ways depending on which stock one will select as 'leading'.
4. Most people forgot the last time the Fed raised rates. I probably had a couple of kids since they did that! They also assure us that it will not happen until at least 2015 or until the unemployment rate gets to 6.5% (whichever comes first?). Clearly, we don't have to worry abut this for now.
5. Looking at the advance decline line, we can see that it is not lagging behind the price action. This means that the current rally has been broad based and many stocks are participating in the advance of the index.
O'Neil does not really suggest to use these 5 indicators simultaneously or cumulatively. These are just the main things he monitors for the possible signal of trouble. For example, 1 and 2 are used for different types of tops. 4 has been relevant in most post WW2 recessions, but clearly not relevant today.
What is the foolish bottom line? Market volume indicates the top may be near, but the advance decline line suggests that there is more space for upside or consolidation, and the 'leading' stocks ( at least in my definition) are supporting that.