When this indicator crosses, I’ll turn bullish

The fact that the Nasdaq continues to lag is a concern. Historically, when the
Nasdaq has lagged, the market has struggled to make headway. This concept was
illustrated quite nicely in Gerald Appel’s recent book “Technical Analysis –
Power Tools for Active Investors”. (One of the better trading books I’ve read
recently.) In the book, Mr. Appel suggests using a 10-week relative strength
indicator to measure the strength of the Nasdaq vs. the NYSE. In the chart below
I have re-created this indicator.

The way the indicator works is as follows: When the red line is above the yellow
line, the Nasdaq is leading the NYSE. When the red line is below the yellow
line, the Nasdaq is lagging the NYSE. What interesting is that since 1971, if
you only owned the market (NYSE or Nasdaq) at those times when the Nasdaq was
leading, you would have made more than if you owned the market for the entire
period. In other words, over the last 35 years, when the Nasdaq has failed to
lead the NYSE, the NYSE has not even managed to break even, and the Nasdaq has
done even worse.

The chart above also shows how well this indicator has worked over the last year
and a half. Buying when the Nasdaq is leading and selling when the NYSE is
leading has kept you on the right side of the market pretty consistently during
this period. The Nasdaq could still step up and take a leadership role in
pushing the market higher. Until it does though, it may be wise to view any
further rally with skepticism.

Good trading,

Rob