3 Great Equity Market Leading Indicators
08/19/2011 7:00 am EST
Factors like option volatility, volume, and price action in gold ETF GLD combine to act as a solid leading indicator for the equities market, explains one trader, citing recent charts as confirmation.
The past few weeks, traders and investors have been completely spooked from the surge of negative news and collapsing stock prices. This fear can be seen just by looking at the volume on the SPDR Gold Trust (GLD). With gold being in the spotlight for several years now, and the fact that anyone can own gold simply by buying GLD shares, it only makes sense that reading the volume on this chart gives us a good feel for what the masses are feeling emotionally.
If we step back to trading basics, we know that fear is the strongest force in the financial market for moving prices. There are a few ways to read fear in the markets, and the more factors that line up at the same time, the higher the probability of a trend reversal in the near future.
There are three things I watch that in combination act as a leading indicator for the equities market:
- The first thing I look for is a rising Volatility Index (VIX). This index rises when investors become fearful of stock prices falling by hedging positions or flat out buying put options to profit from a falling market
- Second, I look for a high selling volume ratio, meaning at least 3:1 shares traded are from individuals hitting the sell button in a panic, thinking that the market is about to collapse
- And last but not least, I look at GLD volume and price action. A surge in GLD volume after a strong move up means everyone is scared and dumping their money into a safe haven
Let’s take a look at some charts to get a better feel.
SPDR Gold Trust (GLD) Weekly Chart
As you can see below, there are sizable price movements that ended with strong volume surges. Those volume surges mean that the majority of investors have reached the same emotional level and bought gold (GLD) for safety.
Keep in mind that the big money players and market makers can see this taking place, and that is when they start selling into that surge of buying volume, locking in maximum gains before there are no more buyers left to hold the price up. Tops generally take a few weeks to form, so don’t expect a one-day collapse.
The recent rally in gold has taken place when stocks have fallen sharply. Money has been pulled out of stocks and been pushed into gold, but I think that is about to change.
The past month has been a bloodbath for stocks. But from looking at the charts, volume, and the fear in the market, I can’t help but think we are going to see higher stock prices. As traders and investors see stocks moving higher, they will pull money out of gold and dump it back into stocks, and likely high-dividend-paying stocks at that.
In short, everyone piled into gold, sending it skyrocketing higher, and I feel gold has moved too far too fast and is ready for a pullback, perhaps a pause lasting two to 12 weeks.
In association with gold’s pullback, I feel traders are now realizing they sold their stocks at the bottom of this correction because fear took hold of their decisions. Now they are starting to think about getting long stocks, but it still may be a bumpy ride for a few weeks yet. Stay frosty, traders.
By Chris Vermeulen of TheGoldAndOilGuy.com