Up days

In a big bull market, there will be more up days than down days. Keeping track of the strength of the market can help you stay focused on the positive trend.

Keep in mind that television financial reporters are trying to make news, so they tend to focus on things that could disrupt the market to keep you tuning in.

A good rule of thumb is three to four up days per week in a bull market, with one to two down days. A down day in which the volume is lighter than the day before suggests more people are interested in buying than selling. Calculating the general direction is a simple thing to do. In Figure 16-1, which shows the NASDAQ 100 Index, the market went almost straight up with three to four positive days every week for about three months. If each week is giving you more up days than down ones, you’re probably in a big uptrend. In general, as long as the market is three days up for every two down, try to ride the trend.

Down days

Stockbroker Bill O’Neil taught most investors to count down days. Specifically, if the volume bar was higher than the day before and the market was down over 0.25 percent, that would be a distribution day. If you start to get too many in a three- to four-week period, be more careful. Five or six higher-volume days can be a harder hit to the market than five or six slightly lower close days.

In Figure 16-1 you can see a collection of big candles on high-volume days that are on down days in June. This is the upper limit of how many down days you want to see clustered together. The days with a higher volume on a down day are marked with little ellipses. This selling over numerous days suggests broader market weakness showing up. It doesn’t say sell everything, but it does suggest some caution for the next few weeks. (If you’re having a hard time reading the chart, review candlestick chart basics in Chapter 4.)

Inside and outside days

The largest volume on Figure 16-1 happened on a Friday. The huge volume shows up on a candle that was inside the previous day. An inside day is when the low is higher than the low of the previous day, and the high is lower than the previous day. The whole candle is within the previous day. Typically, inside days show indecision, but they seem to show up near turning points or reversals in the market.

An outside day is when the candlestick extends above and below the previous day. Candlestick pattern analysis is only a guide to the next five or ten candles, but they can be important clues to watch for. The June 9 outside candle happened on a Friday. After pushing to a new high in the morning, it closed the day lower after starting the day above the previous highs. The price action from that one candle marked the highs for at least the next month, and the market moved lower. The second-largest volume was an outside day and a huge down day after a stellar run-up for most of May. These are also called outside reversal days.

Notice the change in the candlesticks after the outside reversal. The June 9 outside reversal kicks off a period where the candles on the right-hand side of this bar are longer than the ones on the left side of the candle. When the candles are starting to get longer, the average true range is increasing. The average true range measures the candle heights and averages them over 14 days. Seeing them expand means the volatility is increasing, which usually happens as a top is being formed (see Chapter 9 for more about topping patterns). Calm markets don’t usually top out. Eventually one candle is the final high, but the market usually tries to go back and test the most recent high. Sometimes the test is slightly higher, the same height, or lower. The best tests of a previous high come one to two months later. If the tests of the previous high can’t hold above the highs, more caution is warranted.

Figure 16-1 also had outside days on March 21 and April 5. Both of those days marked highs for the next week. The taller the outside day, the more respect it should be given. In candlestick charting, these are considered important days.

Volume and volatility can help you see the change in price action. Figure 16-1 does a great job of demonstrating the three different periods of the market in the chart:

• The left-hand side has a flat sideways consolidation.
• The center has a huge run-up.
• The right-hand side shows increased volume, increased volatility, and downward price movement.

Volume and price bar extremes

Visually keep track of the following points, which can clue you in on how to respond to weird price action:

• Inside days and outside days (we cover these earlier in this chapter)
• Highest- and lowest-volume days
• Largest and smallest candles, including wicks
• Largest and smallest candle bodies

Staying with Figure 16-1 of the NASDAQ 100 Index (which appears earlier in this chapter), the lowest volume occurred on the final low point (April 17) before the market accelerated higher. The highest-volume candle up to that time marked the top. The lows made with the high volume on May 17 continue to be the lows later on in the chart. The market goes down to that level again to see whether more buyers will step in.

The large price candle on May 17 with big volume was the first such shock in months. Paying attention to where those high-volume bars occur is very valuable (the volume bars are below the price chart). High-volume days that occur with an outside day are especially worth noting. While they may not mean anything, they usually mean something. The odds are that something is changing. Outside days are an important signal — as the market moves forward after one of those days, compare the market behavior after with the market behavior before the high-volume day. Does it resume its previous trend?

Compare where high-volume days are. Are the high-volume candles starting to change the character of the market? Are more than just the occasional candle getting really long? On the right-hand side of Figure 16-1, there are eight filled sizable candles over a few weeks. On the left side, there are two, maybe three, in three months.

Volume can help signal reversals. If the price starts to fall meaningfully on higher volume for multiple days in a row, this is usually a bigger clue of a trend change. Stay alert on a high-volume day, but don’t overreact and get out of a good stock too soon. If the high-volume day is making you concerned, research further using other tools in your chart toolkit for time periods shorter than a week to see whether there are other buy or sell signals.

Outside reversal dates on weekly charts

An outside day is when the price bar extends above and below the previous day. An outside week is when the same thing happens on a weekly chart where the price made a higher high and a lower low.

While one outside week may come and go, when multiple weeks start to cluster, the market is struggling to make higher highs. Weekly outside reversals are important clues. In Figure 16-2, the June 9 (2017) candle you saw on the daily chart in Figure 16-1 happened on a Friday, creating an outside week. After pushing to a new high in the morning of June 9, it closed the day and the week lower. The price action from that one candle marked the highs for the next month, and the market moved lower. It becomes a reference candle to keep referring back to.

Weekly charts summarize the market quite cleanly. In Figure 16-2, the uptrend continues with almost every week providing a higher high. The arrows point to outside weeks. Almost every one of them is a bearish candle. The last week of March 2017 is a bullish outside candle. These clusters of outside weeks are significant in marking congestion zones that the market has to work through. Staying in tune with outside weeks can be a simple way to monitor the progress of the market.

Generally, a normal week is a week with higher highs and higher lows. Three conditions suggest watching the market a little more closely:

• A lower low
• A close near the lows of the week after pushing to a higher high
• Outside weeks

None of those are sell signals; they just suggest paying a little more attention to the price action. The last section of this chapter deals with support breaks that may influence selling.

Options expiration days

Options contracts expire on the third Friday of the month, so you typically get increased volumes on that day. Because it is the third Friday, it is not the same calendar date every month. Figure 16-3 shows the options expiration days marked on the S&P 500 Large Cap Index ($SPX). The solid lines are options expiration days, and the dotted lines show quarterly options expiration days.

There are three different series of options expiration (OE) dates. While these dates come and go regularly, the volume associated with them can make them important turn dates for the market, as mentioned earlier in this chapter:

• Options expiration: Regular options expiration occurs in February, May, August, and November. There is still a volume effect, but it’s not as important as the other two cycles. This date may prove insignificant for volume or trend change in the market.
• Options expiration through earnings season: Options expiration during earnings season occurs in January, April, July, and October. The highest volume into the month shows up close to OE. The options expiration that occurs during earning announcements usually marks an increase in volume from earlier in the month. This increased volume can continue into the week following. Looking at Figure 16-3, the volume in January, April, and July starts to pick up just before options expiration. Notice how the volume stays somewhat elevated for the next week.
• Quarterly options expiration: The highest-volume days of each quarter are usually the quarterly options expiration days. They occur in March, June, September, and December. Quadruple witching, which is another name for the quarterly options expiration day, always generates high-volume days — usually the highest volume of the quarter. Even in December, as people are focused around holidays, the volume will be significant.

While there are no tradeable facts around these dates, they will skew your volume analysis. Some of the dates on the chart shown in Figure 16-3 also mark change in trend dates. If the market was going up, it may stall and move sideways. As an example, the OE date marks numerous turns on the chart. December, January, March, April, May, June, and July all have trend changes within one day: from up to sideways, from sideways to down, from down to sideways, or from down to up.

Fed meeting dates

The Federal Reserve (the central bank of the United States) has become a huge part of the stock exchange, and massive attention is paid to the Fed chairman’s every word. The statement after each meeting is scrutinized for the subtlest phrase changes from meeting to meeting. Plotting those meetings also produces meaningful dates on the chart that are associated with higher volume. Figure 16-4 shows the Fed meeting dates plotted on the chart of the S&P 500 Large Cap Index ($SPX).

The Fed meets roughly every six weeks. There are also a few other Federal Reserve events that are widely followed, like the Fed chair testifying to Congress. This chart just keeps track of the Fed meetings. Notice that some of the market tops and bottoms occur on a meeting date.

By nature of the calendar, the Fed always seems to meet within a few days of options expiration (see the preceding section) when it meets mid-month. These meetings occur in the same months the quadruple witching occurs: March, June, September, and December. Between the Federal Reserve meeting and the quadruple witching, these months have extra weightings.

Lastly, be careful about the accuracy of the news media. The November 2016 stock exchange bottom shown in Figure 16-4 occurred in concert with the Federal Reserve meeting, and the rally was well underway after the presidential election. Was it the election or the Federal Reserve that caused a bump in the financial exchange-traded fund Energy Select Sector SPDR Fund (XLE) of 17 percent in the six weeks following? The XLE started rising November 2 and topped on December 14, bookmarked by the Federal Reserve meeting dates.