If You Learn One Indicator, Make It This One
One of the quiet, but growing, problems in the stock market is the outsized influence held by a handful of companies. Just six firms, the FAANGs and Microsoft, make up between 20 percent and 25 percent of the entire S&P 500 (depending on specific prices on any given day).
This creates… well, a lot of problems. Not only does it tie pretty much every investor in the United States to the decisions of a handful of CEOs or boards of directors, but it also undermines the pricing mechanisms that are supposed to govern the stock market. How can investors and economists get a good sense of the U.S. economy at large when the entire S&P 500 can lose value because one company had a weak product launch?
According to the team at Action Alerts Plus, that’s a problem well on their radar. They write:
“There is much more to look at than just price and volume in technical analysis,” the team wrote recently. “We like to see the quality of a move up or down, too, such as when an index goes up, but only because of a few mega-cap names are rallying.”
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In addition, “we like to take a look under the hood to see how powerful a move truly is, because we can be faked out by shallow moves up or down if they are not accompanied by solid breadth and internal indicators. The McClellan oscillator (MCO) is my favorite breadth tool. Simply put, this indicator looks at breadth around moving averages. Breadth can be analyzed differently by different analysts, but it is basically an analysis of up/down issues — how many stocks are going up vs. how many are going down.”
When the AAP team uses an MCO, it helps them to tell the difference between shared growth or losses vs. the value of an individual company. This, in turn, can tell them whether shifts in the S&P 500 represent actual market movement or just the outsized impact of a small number of firms.
This is critical information, because momentum tends to come from shared experiences.
“If more stocks are rising with the market, then there is a good chance momentum takes hold and stocks continue higher. The opposite, of course, is when breadth is poor and stocks are falling.”
Oscillators and momentum trackers are one of the more technical tools in an investor’s database, but they’re well worth understanding. In a market that has become dominated by a small number of players, index price action on its own is an increasingly unreliable indicator. You don’t want to just know what’s happening in the S&P 500. It’s also important to understand why.
