The new high-new low index

Most traders pay attention to the key market indexes that are given to them ready-made, such as the Dow, the Nasdaq, and the S&P. There is one additional market indicator that is much more forward-looking. I believe that the New High–New Low Index (NH-NL) is the best leading indicator of the stock market. I look at it every day to confirm my bullish or bearish stance. NH-NL takes a bit more work to construct, although its formula is very simple.

NH-NL = (New Highs) minus (New Lows)

NH-NL is very easy to track by hand, since the raw data is published daily in all major newspapers. For example, yesterday there were 51 new highs in the market and 98 new lows, giving us NH-NL of minus 47. The day earlier we saw 43 new highs and 130 new lows, resulting in NH-NL of minus 87. Plotting these numbers on a day-today basis gives us three lines: New Highs, which I like to plot in green, New Lows, which I plot in red, and daily NH-NL which I plot in some neutral color.

Plotting the weekly NH-NL is a bit more tricky, as you have to decide when your week ends. I used to plot this indicator by adding daily numbers for the past week, but last year switched to plotting weekly NH-NL as a 5-day running total of daily NH-NL.4 For example, as I write this on a Wednesday morning, my weekly NH-NL for the past night sums up the daily NH-NL for Monday and Tuesday of this week, as well as Wednesday, Thursday, and Friday of the previous week.

New High–New Low Index

A stock appears on the list of new highs when it is the strongest it has been in a year. This shows that a herd of eager bulls is chasing its shares. A stock appears on the list of new lows when it is the weakest it has been in a year. It shows that a crowd of aggressive bears is dumping its shares.

The New High–New Low Index tracks the strongest and the weakest stocks on the exchange and compares their numbers. It measures the balance of power between the leaders in strength and the leaders in weakness. This is why NH-NL is a leading indicator of the stock market. The broad indexes, such at the S&P500, tend to follow the trend of NH-NL.

You can visualize the stocks on the New York Stock Exchange as a regiment. If each stock is a soldier, then new highs and new lows are the officers. New highs are the officers who lead the attack up a hill, and the new lows are the officers who are deserting and running downhill. There are no bad soldiers, only bad officers, say military experts. The New High–New Low Index shows whether more officers lead the attack uphill or run downhill.

When NH-NL rises above its centerline, it shows that bullish leadership is stronger. When NH-NL falls below its centerline, it shows that bearish leadership is stronger. If the market rallies to a new high and NHNL rises to a new peak, it shows that bullish leadership is growing and the uptrend is likely to continue. If the market rallies but NH-NL shrinks, it shows that the uptrend is in trouble. A regiment whose officers are deserting is likely to turn and run.

A new low in NH-NL shows that the downtrend is likely to persist. If officers are running faster than their men, the regiment is likely to be routed. If stocks fall but NH-NL turns up, it shows that the officers are no longer running. When officers regain their morale, the whole regiment is likely to rally.

From Trading for a Living, by Dr. Alexander Elder, John Wiley & Sons, Inc., 1993

Surprisingly few software vendors supply the New High and New Low numbers, but even when they do, those numbers alone are not enough. They need to be processed in a manner described above to make them useful for analysts and traders. Some software vendors process their data in strange ways whose logic eludes me. Kerry Lovvorn, my comanager of the Spike group, has spent a great deal of time and energy to develop a proprietary method of locating this data and transferring it into TradeStation. He sends out a nightly NH-NL update to all members of our Spike and Spike Spectator groups, and when he is busy I do it for him.

I like to track NH-NL for all listed stocks on the weekly and daily charts (see Figures 1.3, 1.4, and 1.5). The weekly NH-NL helps identify major tops and bottoms, while the daily chart is useful for shorter-term timing.

Another extremely important feature of this weekly chart is that its bearish divergences signal traders when to sell their long positions and go short. Notice that tops are broader than the bottoms and the signals to sell and go short are less precise than the buy signals near the bottoms.

Figure 1.3 Weekly S&P500 and New High–New Low Index

Green arrows—downspikes. Red arrows—bearish divergences.

This chart tracks the behavior of weekly NH-NL during the 2003–2007 bull market. It has two striking features. The first is that every bottom of any importance is identified by a downspike of NH-NL. When NH-NL spikes several thousand below zero, it identifies the end of a bear market and the beginning of a new bull market. This chart shows only three such occurrences, but one can see more of them on a very long-term chart (not shown). In an ongoing bull market, a weekly downspike below .1,000 (minus one thousand) identifies the end of a downtrend and a great buying opportunity. The upspikes carry no such meaning.

Figure 1.4 Daily S&P500 and New High–New Low Index

Red line—new highs. Green line—new lows. Blue—NH-NL. Green arrows—downspikes.

This chart tracks the behavior of daily NH-NL in 2007. Whenever the daily NH-NL falls below zero, while the bull market is going on, it gives a buy signal. When it becomes negative it marks a brief imbalance in favor of the bears during an overall bull market. That is the time when many people become fearful and bearish, but NH-NL helps counteract their psychological pull. You can see that the daily chart of NH-NL provides excellent buy signals during a bull market but is not too useful for identifying market tops.

Figure 1.5 Daily S&P500 and New High–New Low Index

The box marks the summer 2006 bottom—new lows stayed above new highs for nearly three months. The length of time NH-NL stays below zero provides an important indication of the durability of the uptrend to follow. Strong uptrends grow out of solid bottoms, when NH-NL stays negative for two or three months. If NH-NL spends only a few days below zero, it shows that the bottom is not too solid. Even if it leads to a rally, that rally, built on a poor foundation, is likely to end in a severe break. Another message of these charts is that it pays to keep good notes—a visual diary of your trading and research. You must remember what has gone on before in order to profit in the future.

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