Thursday, July 24, 2008

Cooking Tools #5: Tick-Talk

Yes, I'm still bogged down in my stop-loss research. Since all of my lackeys are on vacation (haven't they heard of a staycation?), I've got to do it myself. Sigh. Anyway, I guess the candlesticks formed yesterday weren't lying. The market did go down today. Yay me for predicting it. Boo Mr. Market. I'll be watching to see if the VIX breaks above 25. If previous history is any indication, every time it has done that it has also risen above 30, and since the VIX and the market move inversely to each other, this has meant new relative lows for the major indices.

Now the VIX isn't the only indicator of market direction--there are other indicators used by traders such as the equity put/call ratio, the Arms Index (aka the Trin), and the Tick. Today I'm going to introduce the Tick for those of you unfamiliar with it.

What is the Tick and why should I care?
The Tick is nothing more than an indication of directional movement. You can look at the tick on individual stocks or on market indices. Since we're more interested in the markets right now, we'll be referring to the Tick on the S&P 500. Before decimalization, one tick represented the smallest increment in price, say 1/8 or 1/4 of a point. Nowadays, it reflects whether a stock is trading to the upside or the downside. The Tick on an index, however, is slightly different--it reflects the difference between the number of stocks that are trading on an uptick with those that are trading on a downtick. Clearly, if there's a lot of selling, the tick will be a negative number. In general, the majority of Tick values range between 1000 and +1000 on “normal” trading days, but it's those days when the Tick enters extreme levels that traders should take note of.

Tick extremes
Extreme values on the Tick range from around +2500 and above and from -2500 and under. When the Tick hits one of these extreme values, a market reversal is either imminent or will usually occur in the very near future (within a day or two). What the Tick can't tell us, unfortunately, is the extent of the reversal--it could last for months or only a few days. Compare the daily charts below of the S&P 500 with the Tick.

Now you have another tool to put in your arsenal of indicators. Note that by itself the Tick isn't perfect; it's best used in conjunction with other indicators. Not only can the Tick be used to predict daily price movement, it can also be used successfully as an intra-day indicator which daytraders might find useful. (When I was daytrading S&P futures, I used the Tick combined with the Trin, but I'll leave that discussion to another day.) Motto: The market won't tick you off if you take note the Tick!

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