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Understanding The Barometer. 

By Frank Stockwell


The stock market is not short on forecasts and predictions:

You can turn to almost any page of a financial newspaper or magazine, turn on a financial TV station, surf the web and you will find someone that can forecast where the market has come from, where the market is now, and where they think the market is headed.

The only problem is that you have so many forecasts and predictions, one of them, you would think, will be right given enough time. The fact is, almost all of them are based on the internals of the market. You might say- 'well yea, that seems right'.  Maybe not, think about this- forecasters today are too buried in a particular sector or phase of the market. How can you accurately forecast the stock market by studying a handful of stock market metrics, and sometimes it's not even a handful. 

You've heard the famous saying "You can't see the forest for the trees"? Well, you have to be above the forest if you want a global view of it. Same thing for the stock market, you need a tool that maps out the attitude based on the big picture, a view from the top- not within.

That leads me to talk about the Market-Barometer. The essence of the Barometer is the graph that depicts the market attitude. The attitude of the market is either a positive one, negative, or is neutral to the days trading activity. You can certainly judge for yourself when the market is in one of these attitudes by listening to the news coverage each day.

Everybody can discern when the market is positive or negative because you either make a lot or lose a lot. But it's harder to calculate when the market is neutral. And it's very difficult to decide the stock market is positive when the averages and indexes are down for the day.

To fix this problem, the Barometer has two models it uses to make a decision to the market environment of the day. The news model is used to calculate the impact each relevant piece of news has on the overall market indexes. The stock-model portfolio is used to determine the impact the news has on performance of a select number of stocks that represents a mixture of the market.

Both of the models, at the end of trade each day, are manipulated and weighted, then applied to the Barometer as a single plot on the graph. The plot of the day either advances (if a positive day), declines (if a negative day), or goes sideways (if a neutral day) built upon the previous days plot.

So what you get is a series of plots that map out the attitude of the stock market and over time a trend develops indicating how the market is influenced by news.

You are probably asking, 'why news'? Well, because if you think about it, news is what drives the market. If there were no news about anything the market would go sideways because there wouldn't be any reason for the market to go up or down. There wouldn't be an imbalance of buyers over sellers or visa versa if it weren't for news.

If you have an imbalance of buyers over sellers you see two things. One is there would be some news causing more buying than selling, and two, the share price would rise because of the imbalance. The old supply and demand theory.

Think about it for a moment. Why do you buy stock? Why do you sell? For that matter, why do you decide to hold a stock? The reason is because you make decisions based on news about the stock, or the sector the stock is in, or the economy, or world events. Also could be you just need the money. But normally, news is why you decide to buy/sell/hold.

The Barometer is probably the best way to judge the environment of the stock market because it gives you a picture of how news is affecting peoples decisions to buy/sell/hold stock and funds. 

So what does the Barometer chart tell me? It shows you by the trend lines (support and resistance) what the attitude of the market is. If you see the plots generally advancing over a period of time, then you know the environment is positive for buying stock/funds. If the trend is mainly down, you know the market and your stocks/funds may be suffering. Of course, the sideways market can be positive and negative depending on the cycle of the market.

The key to determining the market environment, according to the Barometer, is all in how you interpret the Barometer plots. The plots on the graph are not random, they are arranged according to the cycle the market is in. If you look at the graph you will notice there is a definite pattern to how the plots are arranged. When the market is positive, the plots trend in an upward movement. If the market is negative, the plots generally trend lower. And if neutral, the plots trend sideways.

The trend lines (support and resistance lines) are placed on the graph to outline a trend of the market as it occurs. When a plot, or series of plots, bounce off of one of the trend lines in an upward direction, it is considered to be bullish. When a plot, or series of plots, bounce off of one of the trend lines in a downward direction, it is considered bearish.

In a market such as we have today (August 2002) there are numerous resistance lines on the graph. You know they are resistance lines because the plots tend to bounce off of them in a downward direction, they are unable to penetrate and stay above those lines. That is a classic bear market.

To determine when the market turns from a bull market to a bear market, or visa versa, you look for a trend change. It's not hard to pick out the latest trend change because it is so compelling to see one upward-sloped trend line amongst the other trend lines that are either sideways or down. 

If you take the time to study the chart you will see that it makes all the sense in the world if you have been following the stock market. But always remember one thing, it only takes one bad apple to spoil the lot. This means if real bad news happens that can change the entire picture in a flash. But also remember, real bad news doesn't happen every day.

The bottom line is another famous saying; "the trend is your friend". This means, for the most part, you can trust a trend.  

Frank G. Stockwell is a contributing editor to market-barometer.com. You can e-mail Frank at frank_stockwell@market-barometer.com

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