Saturday, 6 October 2012

EQUITIES MARKET ANALYSIS (October 6th 2012): How we use the Bullish Percentage Indicator, What is BPNYA saying about the Rally?



Readers of our 2011 and 2012 (so far) Reviews will notice we like to use the Bullish Percentage indicator in our analysis for MEDIUM TERM market trends.

2011 was a notoriously difficult year for attempting to manage portfolios in the face of volatility. While we're big fans of using trends in Economic Analysis to assist us, the BPNYA alone might have offered the following guidance last year: 

  • 1) From Q3 2010 onwards, maintaining an increasingly bullish stance
  • 2) From February-April 2011 adopting increasing caution, perhaps consider taking some profits
  • 3) From May-October, revert to being net short, protect downside risk or avoid buying stocks
  • 4) Consider adding to long term holdings in extremely oversold August and early October conditions
  • 5) Gradually ease back in and buy on the dips between October and early 2012
BPNYA from Q3 2010 (after QE2) troughing in July, bullish from September
BPNYA warning us in March 2011, falling to oversold levels and then recovering by 2012

This is of course written in hindsight and perhaps should be treated with skepticism - but the Bullish Percentage Indicator (BPNYA) in 2012 continues to help investors navigate difficult market conditions. At the very least, it helps to indicate how sentiment is evolving in the overall stock market on a month-to-month basis.

BPNYA, the NYSE Bullish Percent Index, is a 0-100% value demonstrating the percentage of NYSE stocks with a "Bullish" Point and Figure char signal. In other words, what % of the broad NYSE market is bullish, and how is that changing over time?

There are many different interpretations for this indicator - at Big Macro Picture, we have a unique way of using it. The Weekly BPNYA chart helps us classify MEDIUM TERM bullish or bearish cycles, which might last anywhere between 3-9 months. Keep in mind those cycles (often for instance, bearish May until September, in many years) take place within bigger LONG TERM cycles - so we can have a bearish Medium Term view within a bullish Long Term view.


We commented on the Weekly BPNYA indicator falling beneath its 20 Week Moving Average in early April this year, when the Dow was around 13000. Being a leading indicator, a sign of the overall market breadth, the market generously gave plenty of opportunities to sell between 12850 and 13300 once the signal was offered in April.

Between May and early June, the Dow fell back to a low of 12050.

The BPNYA in that time would've acted like a sober man advising a reckless friend during a night of heavy drinking.

During the giddy overindulgence of the early part of the year, the BPNYA offered some signs of warning and caution from February onwards. "He's overdoing it now", the sober man might say in March, as his friend (the market) laughed it off, ordering another round of drinks.

While the sober BPNYA has no idea when that giddiness will end, it often knows before the market when the party is over and the night is about to end. It also rarely knows how severe the "sickness" and subsequent hangover will be -- only that hysteria, overreaction and dismay are usually the emotions that come next. "I told you so", the sober man might say, handing his friend a bucket.

And 2012 has often been both exuberant (in March, and arguably now in October) and despairing (in May), where the market is concerned. A sober judge of market breadth is extremely useful while the market is weighed down by economic fears, and subsequently buoyed by central bank easing. As we've alluded to in other articles, June-present has seen a market rally that economic indicators have missed until very recently.


Our BPNYA analysis comes in varying different stages - it is an indicator capable of telling us many things about the "stage" or "mode" the market is in.

In early June, the indicator troughed, and failed to make any more lower lows. In mid-June, BPNYA crossed back above its 20 day moving average and stayed above it, the first traditional short term "buy signal" often used by swing traders.

In early August, it crossed back above the 20 week moving average - which should normally serve as confirmation that a MEDIUM TERM bear phase has ended, and a new month-to-month bull phase had begun. At that stage, we can more confidently buy dips in the US indices.

The BPNYA tends to show us trends in the market without much fuss or noise, in normal market conditions. Simply following this trend from June onwards would have yielded satisfactory results - and that trend is usually fairly clear, making striding white Marubozu candles on most weeks.

Then, in the second week of September, BPNYA crossed above the 70 level. This is an interesting point - where an investor can take two different views. The market enters a stage of exuberance when making sustained moves above 70 on BPNYA, as a considerable majority of US stocks look bullish. So our first point of view is, "don't stand in the way of the market", as the market is likely to push ahead. We might want to close short positions on dips, or temporarily shed some of our downside protection - with a view to getting better prices to do so later.

The second point of view is that when the market gets carried away, it can often become overbought, and ugly scenes can ensue if that trend changes. So, at that stage, we're also waiting for the market to run out of steam. When BPNYA flattens out, and then begins diverging/falling sharply, we know to reverse positions or take profits.

Charts Courtesy of the Excellent

We can see this on the chart above - note how quickly and definitively the trend changes in early June, and how the 20 week moving average is crossed in early August.

This brings us to our crossroads point in October 2012. The BPNYA hasn't made a new high in a couple of weeks, and since mid-September has been consolidating. In 2011 and earlier this year, BPNYA spent 9-10 weeks consolidating in this way - making new Dow/S&P highs in the process - before diverging from the market and falling.

Similarly, despite BPNYA not powering into the overbought 70s levels, the Dow closed at a new cycle high on Friday. We will continue to watch the market breadth indicators for developments as it remains in this consolidation phase. If it begins to fall violently, diverges from the market, or continuously fails to make new highs along with the market, we will begin to take profits on long exposure.

On the other hand, if it makes new highs and embeds itself above the 70 level, we will continue to take BPNYA as strong evidence that the rally could continue - and that 14000 may come sooner rather than later on the Dow Jones Industrial Average.

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