Unsustainable? This Indicator Shows a Market Consolidation Warning.

My dad has been watching the Mecum Car Auction looking for a 69 Camaro since I was a young boy. A month ago, he finally got it, and has been reliving the glory days! I must admit, it’s awesome. So, how does a 69 Camaro teach us about the market? Drive Read on!

 

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I hate to say it, but the Camaro is not the market indicator, it’s just cool to look at. What reminds me of the current market condition, however, is the auction experience. Even if you’ve never been to a live auction, imagine with me the experience.

 

A priceless heirloom is rolled out and unveiled. The Crowed gasps in amazement! Next, the auctioneer begins. “Let’s start today’s bidding at $100!… ”

 

What transpires next is a bidding frenzy. Dozens of people frantically waving their bid-cards as the auctioneer talks faster than a 1980’s, vintage micro-machines toy commercial. Before you know it, the price has skyrocketed, and the auctioneer continues

 

“$19,000… who will offer nineteen thou… Ah, yes! The southern belle in the blue hat… 19,000, who will give me 20,000…”

 

On and on it goes until Ms. Southern Belle and a New York Real Estate Mogul are the final two going head to head. The room has grown quiet as the price continues to increase… slowly. At this point, neither wants to over-bid.

 

Finally, the Southern Belle wins the auction! The price is finzlized and the entire process stops. Said differently, the bullish price-run on the heriloom is over for now.

 

Take note, in the begining of the “bullish price action,” there were lots and lots of people participating in the price increase while at the end, only a couple bidders continued to drive the price higher. In retrospect, we may be able to analyze this behavior and ultimately determine at about what point the price was going to stop trending higher.

 

Is the market so different? Perhaps the market is actually an ongoing auction where people bid on the value of a company. It’s not a perfect metaphor, but it is interesting to consider.

 

For example, we might take a look at the number of companies that are moving higher (Advancing) vs. those that are moving lower (Declining) on any given day. To help identify a trend, we might also add a 7-period moving average to this chart. This is what it would look like.

 

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Notice, fewer and fewer companies are participating in this “auction”? Now, compare this to price action on the Dow Jones Industrial average. Perhaps this is starting to feel like the conclusion to our auction story?!

 

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Another measurement we might look at is the number of shares being traded on advancing vs. declining companies. The chart below shows Up-Volume vs. Down-Volume. Again, notice the number of shares (I like to think of this as “people”) is declining.

 

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This is not sustainable. Either price must consolidate (or decline), or more companies and people must return to the “auction” floor. In my opinion, price typically follows the market breadth indicators we just discussed.

 

I do not believe we are looking at a massive market selloff here. However, as I told my students in last Monday’s Trading Lab – “This is the time to exit positions and put cash in your jeans, not open new trades.” Currently, I am forecasting and preparing my trades for a market consolidation or a brief retracement.

 

If you would like to learn more about the importance of market breadth indicators and how they can help you time your trades the Mastery Class “Strength Training – Understanding Market Vital Signs” is included with every Platinum members at TradeSmart University. Use the link below to start your 2-week FREE TRIAL and watch the class today!

 

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