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It might seem obvious, but the stock market is a market of stocks, DUH! But when we constantly hear about stocks like AAPL and TSLA we might forget that there is an ocean of publicly traded companies, and some are good, some are bad, and some are outright frauds!

Elite traders are market professionals, and just like other professions, we must stay up to date with what is happening in our industry as a whole. Market Breadth is a way of analyzing the stock market’s health, just like a doctor might explore a heartbeat or pulse of a patient.

Today we will discuss this essential indicator, how traders use it, and how it can be used to improve trading skills.

Market Breadth

Market Breadth indicators analyze the number of stocks advancing relative to declining in a particular market index or exchange. It is critical for traders to analyze the strength of a specific market rally and provide clues about whether a move is sustainable or if a correction might be near.

The more stocks are advancing than declining— the more bullish the market sentiment and likely the market rally can be sustained. When the market is really strong, the rally is broad across sectors.

Advance-Decline Indicator

One way to analyze market breadth is to look at the number of Advance-Decline Issues ($NYAD in StockCharts). It simply shows how many stocks are advancing versus declining in any given period on the New York Stock Exchange (NYSE).

Here is an example of the $NYAD. What we’ll find is in the days where more stocks are participating in the rally than usual, i.e. a reading holding at around 2000 and above, those are the days that the SPY will more likely have a larger move than usual. This is when the SPY expands its range and trends all day, i.e. known as a trend day.

The 3 largest trend days in the SPY are highlighted above in the $NYAD and below on a chart of the SPY.

They were the 21st of June, 9th of July, and 20th of July. One simple way to use this indicator is to simply avoid shorting market stocks or the SPY on days where $NYAD is holding at or around 2000 as those are days that the SPY may be more likely to close on its high.

We could also be more on alert to buy pullbacks or have greater conviction in joining trends in our favorite strong market stocks on such days.

Nasdaq Percent of Stocks Above 200 Day Moving Average (EOD) Indicator

Another Indicator we can use to analyze market internals is the Nasdaq Percent of Stocks Above 200 Day Moving Average ($NAA200R in StockCharts).

In order for a market rally to be sustained, market breadth should continue to be positive with the Indexes. This is exactly what we saw in the QQQ’s and the $NAA200R from the April 2020 Covid lows to the highs in February 2021. However, since then we have seen a divergence.

What has taken place is a rotation out of smaller cap tech stocks and into the larger FAANG names, i.e. Facebook, Apple, Amazon, Netflix, Google. Thus, the larger market cap stocks have gone to new highs whilst money has rotated out of smaller tech companies. The $NAA200R gives a good representation of the market internals of NASDAQ tech names.

Now one of two things is likely to happen next. Either investors will find smaller tech companies attractive at these prices and the $NAA200R will help the QQQ’s continue to march higher. This is the more probable outcome in a normally cyclical bull market. Or alternatively, this is an early sign of weakness in the tech sector as a whole and will lead to a correction in larger cap tech stocks and the QQQ’s.

If we take a look at the weekly $NAA200R chart over the last 20 years we can also see that when we see 80% of stocks in the Nasdaq above the 200-day, that tends to be a sign of euphoria and signals a short term top in these names may be near.

In contrast, when only 10% of stocks are above the 200-day moving average, this extremely low percentage is a sign of max fear and that a short-term bottom in most tech names may be at hand.

Bottom Line

Market Breadth gives us a snapshot of what is happening within the stock market as a whole. Like a doctor using a surgical microscope, Market Breadth allows us to see inside the internals of the stock market, including how many stocks are making new highs, which is very important in identifying the state of the health of a market. Indicators such as Advance-Decline and What percentage of stocks are above the 200-Day moving average give us a deeper understanding of how the market is acting and give us better context when looking for trading opportunities.

 

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

Look under the hood of the broader stock market right now and you’ll see a picture that looks nothing like the major indices that are so often quoted by the financial media.

Sure, you’ve probably heard about the historic underperformance being delivered by small caps in recent weeks.

But have you heard about the battle between cap-weighted and equal-weighted indexes that’s also taking place?

Cap-weighted indexes like the Nasdaq Composite Index, the Dow Jones Industrial Average, and Standard and Poor’s 500 Index are calculated by using a company’s market price and the number of outstanding shares to determine the percentage weighting of the company’s inclusion in the index.

Quite simply, the larger the company, the larger that company will be weighted in the portfolio.

In contrast, equal-weighted indexes are constructed by distributing the same investment amount into each company stock in the same pro-rata amount.

In other words, no matter the company’s size, each company is represented equally within the index.

I’m about to show you the pros and cons to using each strategy as either a trading vehicle (via ETFs, for example) or as a tool for analyzing the markets, and I am going to reveal what each strategy is telling us about the market right now.

How should traders view the differences between cap-weighted and equal-weighted indexes?

There are of course pros and cons to each strategy.

So, which is best?

When it comes to cap-weighted indexes, from a trading perspective, these vehicles largely mock the movement of larger, stronger, more stable companies, offering investors a relatively favorable risk profile.

From a research perspective, these vehicles are more sensitive to the economy, and therefore can be seen as a more reliable window into any signals that the economy might be sending.

On the flipside, however, investors are at risk of missing out on potentially huge gains during those periods when the business cycle favors smaller companies.

In almost the same light, investors risk having poor diversification, and being over exposed to just a few mega-cap companies, if they happen to be overweight these large indexes.

For equal-weighted indexes, the benefits are equal diversification and having more exposure to the small-cap and mid-cap companies that may have a higher growth potential.

At the same time, though smaller companies have a higher risk of failure, there’s no clear distinction of stock size in relation to the economy, and rebalancing may lead to higher stock turn-over rates.

It’s important to understand that the S&P 500 is the cap-weighted index that the financial news outlets love to quote at every opportunity.

The popular vehicle for tracking and trading this index is the S&P 500 ETF (SPY).

Its much lesser-known fraternal twin, the equal-weight S&P 500 that trades via the ETF symbol RSP is almost never mentioned by the financial media.

Again, this is the media we’re talking about, so if it’s not sexy, it’s not worth printing.

But I digress.

Recently, the “mega-cap” stocks have been the main driver of the broad market’s move higher, and this is best represented on the chart directly below, where we see SPY making new highs vs. the struggling RSP.

Figure 1

Interestingly, while RSP has been trading sideways for the past couple of months, raising concerns among some Wall Street analysts, it’s actually still slightly ahead of SPY on a year-to-date basis (RSP + 16.9% YTD vs. SPY + 15% YTD).

Recently, though, RSP’s YTD lead over SPY has been declining rapidly since peaking in May/June.

Essentially, RSP has given up nearly all of its 2021 outperformance against SPY over the past two months.

This aggressive underperformance can be seen on the right side of the RSP / SPY ratio chart on the bottom panel of the chart below.

Figure 2

The other noteworthy observation is that RSP usually shows periods of weakness similar to this only during cycles of broad market weakness (see red lines on Figure 2), not when it’s trending near record highs.

Bottom Line

Again, when it comes to the broader equity market, it’s important to understand that there’s another world other than the one the financial media forces the untrained to focus on.

Unfortunately, this uncharacteristic weakness during a broad-market rally by the lesser-known equal-weighted S&P 500 (RSP) is sending mixed signals.

Equity market bears say the divergence can be interpreted as a possible early warning sign that the broad market is about to follow and roll over.

At the same time, though, bulls see the recent weakness as healthy rotation that is about to resolve itself in the form of the RSP showing strong leadership over the cap-weighted S&P 500.

Whatever the outcome, it’s probably safe to say that if the bulls are correct, and rotation back toward RSP leadership is about to occur, this rotation probably has to start happening soon.

 

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

On July 11th, the Euro 2020 Tournament was finally played after facing a COVID-19-related delay. The tournament, which pinned the best soccer teams in Europe against each other, crowned Italy as the champion over England in a thrilling match that was decided by penalty shots.

In terms of US viewership, the Euro 2020 Final was the most viewed Euro tournament game ever, with 6.5 million viewers.

Viewership for the Euro 2020 tournament was up 31% from the 2016 tournament, and the strong ratings come at a time when the popular media company that aired the game is about to hike membership fees for one of its services, in a move that signals the company is starting to view the service as a stand-alone product.

Recent events have led to a breakout in this stock’s price, resulting in a pre-earnings setup that creates a strong foundation for premium sellers to set up a bullish trade.

I’m about to show you how to set this trade up in a manner that offers you defined risk against a well-defined area of protection.

Disney is making moves, causing positive rotation in its stock price

Disney is set to hike the monthly subscription fee for ESPN+ by one dollar, though the bundle that includes the sports streaming service will remain the same price.

In August 2021, Disney will hike monthly subscription fee for ESPN+ up to $7 a month, up from $6, in a move that mirrors a similar price hike for the Disney+ streaming service back in December 2020.

After a hugely disappointing 2nd quarter, where the stock returned -5.3% vs. the S&P 500’s +8.6% return, Disney stock has started to turn the corner recently, rallying above a 5-week range to levels not seen since mid-May this past week.

Fueled by a combination of recent bank upgrades, its highest grossing movie release (Black Widow) since the start of the pandemic, and the above-mentioned ESPN+ price hike, this breakout puts the stock into a bullish momentum regime for the first time since March.

With earnings now just one month away, at a minimum this price and momentum rotation offers favorable odds that a floor is being put in place.

Since there is no pattern indicating price is poised to rally aggressively from here, which would favor the purchase of call options, but we do feel that the bias is starting to rotate bullishly, the highest probability trade would be one that will benefit from limited downside risk and the passage of time.

I’m talking about a vertical credit spread.

We’ll talk about the specifics of this trade in a little bit.

For now, let’s look at the chart setup.

What are the technicals suggesting?

Although hindsight is 20/20, we should start our analysis by looking at some of the technical developments that may have helped a trader determine that price was close to forming a bottom earlier this month.

To begin with, the bullish July 8th reversal formed after DIS opened near a confluence of support levels, which came in the form of the mid-May pivot area and rising 200-day moving average (see green circle on Figure 1).

On its own, this gathering of big support levels was enough to indicate that, at a minimum, some degree of technical bottom feeding was likely to develop in that area.

The more bullish developments at the time, though, came from positively diverging momentum and volume accumulation (see top 2 studies on Figure 1).

Specifically, the downside approach to the aforementioned support bundle in the $167 to $170 area was accompanied by positively diverging RSI and MACD momentum indicators (an indication that downside momentum had slowed) and by a rising Accumulation/Distribution line (an indication that there was net accumulation of shares during the early-July price slide).

Figure 1

How can a trader benefit from simply having a bullish bias?

At RagingBull, we’re all about finding the chart setups with favorable profit potential and minimum risk.

When it comes to risk management, perhaps no options strategy is better suited than the vertical credit spread.

Let’s walk through the particulars of how we would want to go about placing a vertical credit spread known as a “bull put spread” for DIS in the coming days.

When it comes to learning multi-leg options strategies, vertical credit spreads are among the easiest, and are therefore a great place to start.

Why are they relatively easy to comprehend?

Because they include either selling one put and buying one put (bull put spread) or selling one call and buying one call (bear call spread), and only include options of the same expiration month.

The maximum gain that can be earned from a credit spread is the net credit, realized when both options expire out of the money.

The maximum loss potential is the difference in strike prices – net credit. Realized when both options expire in the money.

In the case if DIS, the trade setup would be as follows:

  1. Identify the trade bias (we’ve identified a bullish setup)
  2. Identify where the stop-out level is (let’s call this the anchor point).
  3. Identify the strike levels that will allow you to enter the trade with what would ideally be no worse than a risking 4 to make 1 setup. There is some leeway here, but generally you should try not to risk more than 4 to make 1.

Let’s break each bullet down a bit further.

For bullet 1, the highest probability trades usually occur when a trader is trading with the trend, not against it.

In this case, we’re using the higher slope of the 200-day moving average as our indication that the long-term trend is up.

For bullet 2, we identified earlier that the 07/08 pivot low formed near an area of major support.

If the long-term uptrend is to continue as part of our original thesis (i.e., the reason for entering the trade in the first place), then price cannot fall below the 07/08 pivot low.

Therefore, the 07/08 pivot low of $169.81 is the ideal stop level (i.e., the anchor point).

When it comes to bullet 3, this is where we must start exercising patience.

I’m constantly preaching how important it is not to chase trades and to let the trade come to you.

When it comes to this DIS trade idea, the trader’s ideal spread entry would be for him or her to be able to sell a put option that anchors as close to the $169.81 pivot low as possible and buy a put option with a strike that is roughly $5 to $10 below that area.

As figure 2 below reveals, however, at the time of this writing on 07/16, with the stock trading near $181.64, in order to anchor the trade near the $169.81 pivot low would require the trader to take on a risk/reward profile of 7/1.

Figure 2

Now, there are a lot of traders that would take a much more aggressive approach than this, by establishing a spread that is much closer to the current price of $181.64 to create potential to collect a much larger credit and a better risk/reward profile.

At the time of this writing, that risk reward setup would have looked something like this.

Figure 3

While this is an ideal risk/reward setup with the largest profit potential, there is an issue that many new traders only learn through practice.

The problem with this approach, is that after such a relatively large price rally like the rally staged by Disney’s stock from 07/08 to 07/12, the potential for a deeper pullback is elevated.

If a deeper than usual pullback happened to occur, it would cause the spread to generate an unrealized loss in the portfolio in the early stages of the trade, before theta decay has had a chance to accelerate, that will be rather uncomfortable and may result in the trade stopping out prematurely.

Remember, there are thousands of stocks that are available to trade.

You don’t have to trade everything and the ones you do trade should be traded on your own terms.

Therefore, if you really like the trade and feel that there will be a minimal pullback as the trend starts to rotate higher ahead of earnings, you could look for the next big level of support that exists before the 07/08 pivot low of $169.81.

As Figure 1 above shows, that support area is $178.50 to $176.50 (see green line on Figure 1), where the 07/12 breakout point combines with the 34-day moving average (not shown) and 50% retracement of the 07/08 through 07/12 rally (also not shown).

If a trader happened to sell a put to anchor the “bull put spread” in the $178.50 to $176.50 area at the time of this writing, the trader would stand to collect a smaller premium than in the example above; however, Figure 4 below shows the risk reward setup (3/1) would be far more favorable than the 7/1 ratio that would have been established in the first example (see Figure 2).

Figure 4

Bottom Line

In today’s example, establishing a vertical credit spread to reflect a trader’s bullish bias during the lead-up to earnings would limit a trader’s profit potential vs. buying just straight calls (buying calls offers unlimited profit potential).

However, the defined risk of a vertical credit spread (calls have undefined risk) and theta-friendly nature of these trades (vertical spreads benefit from the passage of time, whereas the value of a call option deteriorates over time) give these trades a much higher probability of success than just buying straight calls.

Though favorable in terms of their winning rate, placing these trades at the wrong level too early into the trade does open the door to large account drawdowns that may force the trader to exit the trade prematurely with a loss.

That’s why it is so important to be patient and always work with the price chart to find setups that fit your risk/reward comfort zone.

 

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.