Page 349 - How to Make Money in Stocks Trilogy

M = Market Direction: How You Can Determine It 225

For example, if the Dow is up 100 and the S&P 500 is up only the equiv-
alent of 20 on the Dow for the day (the S&P 500 being a broader index), it
would indicate the rally is not as broad and strong as it appears. To compare
the change in the S&P 500 to that in the Dow, divide the S&P 500 into the
Dow average and then multiply by the change in the S&P 500.
For example, if the Dow closed at 9,000 and the S&P 500 finished at 900,
the 9,000 Dow would be 10 times the S&P 500. Therefore, if the Dow, on a
particular day, is up 100 points and the S&P 500 is up 5 points, you can mul-
tiply the 5 by 10 and find that the S&P 500 was up only the equivalent of 50
points on the Dow.
The Dow’s new high in January 1984 was accompanied by a divergence in
the indexes: the broader-based, more significant S&P 500 did not hit a new
high. This is the reason most professionals plot the key indexes together—to
make it easier to spot nonconfirmations at key turning points. Institutional
investors periodically run up the 30-stock Dow while they liquidate the
broader Nasdaq or a list of technology stocks under cover of the Dow run-up.
It’s like a big poker game, with players hiding their hands, bluffing, and faking.

Certain Psychological Market Indicators Might at Times Help
Now that trading in put and call options is the get-rich-quick scheme for
many speculators, you can plot and analyze the ratio of calls to puts for
another valuable insight into crowd temperament. Options traders buy calls,
which are options to buy common stock, or puts, which are options to sell
common stock. A call buyer hopes prices will rise; a buyer of put options
wishes prices to fall.
If the volume of call options in a given period of time is greater than the
volume of put options, a logical assumption is that option speculators as a
group are expecting higher prices and are bullish on the market. If the vol-
ume of put options is greater than that of calls, speculators hold a bearish
attitude. When option players buy more puts than calls, the put-to-call ratio
index rises a little above 1.0. Such a reading coincided with general market
bottoms in 1990, 1996, 1998, and April and September 2001, but you can’t
always expect this to occur. These are contrary indicators.
The percentage of investment advisors who are bearish is an interesting
measure of investor sentiment. When bear markets are near the bottom, the
great majority of advisory letters will usually be bearish. Near market tops,
most will be bullish. The majority is usually wrong when it’s most important
to be right. However, you cannot blindly assume that because 65% of invest-
ment advisors were bearish the last time the general market hit bottom, a
major market decline will be over the next time the investment advisors’
index reaches the same point.