What to Look at When the Charts Aren’t Saying Anything

Yesterday stocks generally rose as U.S. investors looked forward to the Q1
earnings season, which began after the close with the usual release of earnings
from Alcoa (NYSE: AA ). This was in contrast to lower European markets, which
felt the brunt of Germany and France's pressure on other eurozone members to
get their houses in order amid rumors that the eurozone may be dissolving. U.S.
markets traded within a narrow zone due to an absence of news, but the Dow Jones
Industrial Average rose 33 points to 12,393, the S&P 500 gained 3 points at
1,281, and the Nasdaq advanced 2 points to close at 2,677. The Big Board traded
721 million shares and the Nasdaq crossed 475 million. On both exchanges breadth
favored advancers by about 1.5-to-1. Since there was little in the way of new
technical developments yesterday, I'll take this opportunity to discuss other
forms of technical analysis than charts despite their importance in determining
the primary and secondary direction of markets. The two types of indicators
generally used by technicians are "internal indicators" and "sentiment
indicators" sometimes called "contrarian indicators." Examples of internal
indicators that we use are MACD, stochastic, momentum and relative strength
index (RSI). The sentiment indicators are considered contrarian because the
gauge investor emotions, which are usually wrong. Most investors, no matter how
rational, usually buy at the top and sell at the bottom. This is due to either
being afraid of "missing the boat" or fearful of further losses. This herd
mentality is called market sentiment. Thus, when market sentiment is high, most
believe the market will head higher, and when sentiment is low, the majority
feel that the market will head lower. Therefore, professional traders and
institutional investors focus on the extremes of public sentiment in order to
gauge the best time to enter or exit markets. The indicators that they use most
are the CBOE Volatility Index (VIX), the put/call ratio, mutual fund money
flows, and the AAII Sentiment Survey. The CBOE Volatility Index (VIX) is often
called the "fear index" and is released in real time by the Chicago Board
Options Exchange. It is based on the number of puts and calls outstanding, and
when low it is considered to be complacent (bullish), and when high it is
considered to be showing fear (bearish). Further explanation of the VIX is
available here . The put/call ratio is calculated by taking the ratio of the
volume of puts over the trading volume of calls. Thus, low investor sentiment
occurs when there are a large number of puts versus calls. The put/call ratio
may be found here . Mutual fund money flows are often reviewed to determine the
direction of "dumb" money. The study is published by the Investment Company
Institute and updated weekly. In the past five weeks, the data shows money
flowing from mutual funds with increases in bond funds and cash a bullish
indication. As for the AAII Sentiment Indicator, we've covered this in detail
in the past. The survey is published weekly and can be found here . Stock charts
are used by technicians as a primary source for determining the market's
direction, however, the study of the secondary sources indicators, both
internal and sentiment often provides support for the charts' direction and
sometimes gives a hint of future change. And if you are looking for profitable
option trades, you may want to check out my colleague Joe Burns .