Investors are always looking to make the most out of any market situation. Therefore, it helps to note when the market top is making an entry. It will eventually face a correction, potentially eroding significant value out of a portfolio. Investors want to sell out once a bullish market peaks out. However, just how does one keep abreast with the market changes in the face of so much hullabaloo? The dynamic nature of markets requires that you know the key signs discussed in this article so as not to watch your gains wiped out.
Forces of demand and supply bring about a market peak or bottom. Just like other economic situations. Most common stocks trade freely in open markets. Therefore, their price movements reflect changes in demand and supply. A market top means consistently high prices.
In reality, though, it is not easy to identify a peak market until a price correction is imminent. After studying different stock markets around the world, Lowry Research Corporation concludes this. Money movement into and out of stocks markets is indicative of an imminent bull or bear market. As a result, I put together these three key signs of a market top.
Different investors have different tools they use to measure the performance of a stock market. However, for those observing the entire market, a rising number of 52-week highs indicate a bullish sentiment. We expect stocks and securities to break annual records in a bullish market.
However, as most investors appreciate, a price correction is inevitable. Moreover, few can predict it. Rising prices of stocks and securities indicate that more stocks are participating in the bull market. More investors are excited. Additionally, new investors are attracted to the markets who compound the euphoria and drive prices even higher.
The contraction of the number of 52-week highs should serve as a reminder that the market peak has occurred. That is even if major indexes keep an upward trajectory. It signifies that fewer stocks are participating in the market.
More significantly, less 52-week highs imply stagnating stocks. There are few fundamental aspects to justify the rise of the participating stocks in the market. This leads to investors looking for better stocks with growth potential. In turn, this triggers massive sell-offs and downward price movements.
52-week highs are not sustainable in the long term. That is why the markets are cyclical in nature. They occasionally move from peak to bottom. The moment a stock shows signs of laggardness, the investors sell out in favor of better performers. Meanwhile, the stock and its relatives in the industry and the sector respond, sending shock waves in the entire market.
Nonetheless, if the fundamentals are strong, securities and indexes keep breaking the 52-week range records. Smart investors avoid buying a stock at its peak. They understand that a market top heralds a slump in prices.
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The Advance-Decline (AD) line is an indicator of the breadth of net advances. One can calculate it by subtracting the number of declining stocks from advancing ones. The NYSE AD line rises when the net advances value is positive and falls when negative. A change in the AD line can signal bullish or bearish market sentiments.
When the NYSE AD line hits new highs, then there is an almost unanimous bullish sentiment in the market. All market observers, money managers, and analysts observe a sustained growth in prices. They make the investing public believe the rise will be sustained. The resulting situation is that all caution goes down the drain.
The biggest risk of a unanimous bullish sentiment by analysts of trust, fund managers, and investors with experience is this. They influence the bulk of investors who trade based on “what the public is saying.” This leads to more buys, more demand for stocks and even higher prices. Ultimately, it leads to a peak in the NYSE AD line.
A peak in NYSE AD line can be misleading because it relies on market sentiment. It shows that selective market indexes are rising at the expense of the wider market. The chart below illustrates the NYSE AD line.
The peak also indicates that investors are spending all their resources on becoming fully invested. However, it reaches a time when there is no more money to buy new stocks. Moreover, as very few people are selling, supply is low. A massive sell-off and an outward movement of money follow. This paves the way to the start of a bearish market.
Demand and supply are the key determinants in a market. They affect the price and volumes at which stocks and securities trade. However, institutional investors are more influential than small-scale individual investors are. They can buy or sell significant volumes of a stock or security. This has an effect on the market indexes like the Dow Industrial Average, the NASDAQ Composite or S&P 500 derivative indexes.
Institutional investors are usually more heavily invested. Tracking their activity can aid in noting a market top before it shows up. This makes distribution days an important phenomenon. Distribution is where big money managers and investment firms start selling their stocks. Even when prices seem to be going up. Let’s say more of the institutional investors chose to sell off their stock. Then the major indexes take a slump of between 0.2% and 0.3% or more. That’s against a bigger volume than the previous day, constituting the distribution day.
The underlying importance of distribution days is their emphasis on the relation between price and volume as reflected by authoritative indexes. However, a single distribution day is not problematic in isolation. Trouble sets in when there is a trend. Also when there are closer or even consecutive distribution days. It means that more fund managers and institutional investors such as the big firms of Wall Street are getting more aggressive in selling their stocks. It is not long before individual investors follow suit.
The reflection of distribution days in major market indexes is perhaps the reason why most investors watch the indexes more closely.
Monitoring when the next similar event will happen remains the top agenda for most investors. This means that you cannot buy a well-performing stock in terms of price hikes and stop there. You have to follow up with a closer than usual market analysis. A market top indicates the onset of a price correction. A situation which can see your annual gains eroded in a matter of days. Observing NYSE AD line peak, slumps in the big indexes and the contraction of 52-week highs can help you identify a market peak. Please share your thoughts, experiences, and questions, as I would love to hear from you.
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