Page 350 - How to Make Money in Stocks Trilogy

226 A WINNING SYSTEM

The short-interest ratio is the amount of short selling on the New York
Stock Exchange, expressed as a percentage of total NYSE volume. This ratio
can reflect the degree of bearishness shown by speculators in the market.
Along bear market bottoms, you will usually see two or three major peaks
showing sharply increased short selling. There’s no rule governing how high
the index should go, but studying past market bottoms can give you an idea
of what the ratio looked like at key market junctures.
An index that is sometimes used to measure the degree of speculative
activity is the Nasdaq volume as a percentage of NYSE volume. This mea-
sure provided a helpful tip-off of impending trouble during the summer of
1983, when Nasdaq volume increased significantly relative to the Big
Board’s (NYSE). When a trend persists and accelerates, indicating wild,
rampant speculation, you’re close to a general market correction. The vol-
ume of Nasdaq trading has grown larger than that on the NYSE in recent
years because so many new entrepreneurial companies are listed on the
Nasdaq, so this index must be viewed differently now.

Interpret the Overrated Advance-Decline Line
Some technical analysts religiously follow advance-decline (A-D) data. These
technicians take the number of stocks advancing each day versus the number
that are declining, and then plot that ratio on a graph. Advance-decline lines
are far from precise because they frequently veer sharply lower long before a
bull market finally tops. In other words, the market keeps advancing toward
higher ground, but it is being led by fewer but better stocks.
The advance-decline line is simply not as accurate as the key general mar-
ket indexes because analyzing the market’s direction is not a simple total
numbers game. Not all stocks are created equal; it’s better to know where
the real leadership is and how it’s acting than to know how many more
mediocre stocks are advancing and declining.
The NYSE A-D line peaked in April 1998 and trended lower during the
new bull market that broke out six months later in October. The A-D line
continued to fall from October 1999 to March 2000, missing one of the mar-
ket’s most powerful rallies in decades.
An advance-decline line can sometimes be helpful when a clear-cut bear
market attempts a short-term rally. If the A-D line lags the market averages
and can’t rally, it’s giving an internal indication that, despite the strength of
the rally in the Dow or S&P, the broader market remains frail. In such
instances, the rally usually fizzles. In other words, it takes more than just a
few leaders to make a new bull market.
At best, the advance-decline line is a secondary indicator of limited
value. If you hear commentators or TV market strategists extolling its