NASDAQ Summation Index

When it comes to market breadth indicators, I have particular fondness for the McClellan Summation Index, which I have discussed in this space several times in the past year. While the McClellan Summation Index draws upon NYSE advance decline data, I am actually a little bit partial to the NASDAQ variant. For those who use StockCharts.com, the ticker for the NASDAQ summation index is NASI and the NYSE/McClellan version is the NYSI.

So here is the big question: is the historically low NASI advance decline data a buying opportunity or a warning sign?

In order to best answer that question, I have included a chart below that plots NASI data going back ten years. It clearly shows that buying on any significant NASI dip (say -900 or lower) since the October 2002 bottom has been an excellent investment tactic, as was the run up to the 2000 market top. The graph also shows, however, that during the 2000-2002 bear market, this was a risky strategy that tried to capture short bounces which were brief countertrends against a falling tide. It was possible to be successful, but tight stops and/or a narrow time horizon were needed to control risk.

When all is said and done, we are back to a discussion about whether it makes sense to buy on the dips. In a well defined uptrend, there is not doubt that this is a winning strategy. In a bear market, one can still make money on the bullish countertrend, but these need to be surgical strikes. There isn’t much in the way of sideways action evident in this long-term chart, but it is safe to conclude that buying on the dips in a non-trending market – classic oscillator-based trading – is less profitable than trading with the trend, but offers more substantially opportunity than trying to trade against it.

My current reading of the NASI is that we are more likely than not to get a bounce off of current levels; if it turns out we are in a bear market, these gains will be short-lived, but if we are putting in a bottom of at least intermediate-term length, there is considerable opportunity to the upside.