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- 1998: Volume 7, No. 3
NYSE Bullish Percent as an S&P Indicator

By Thomas J. Dorsey

The new Wall Street paradigm has changed considerably of late. It has changed from the old "buy low, sell high" paradigm to " buy high and try to find a greater fool to buy still higher." Investors have come to believe their god given right is a 30 percent annual return. My senior portfolio manager at Dorsey, Wright Money Management, Mike Moody, recently described the situation as follows: "There is no generally accepted measure of risk in the investment industry. People with modern portfolio theory backgrounds will sometimes call beta or standard deviation "risk," but both are really just measurements of fluctuation. Actually investors are never bothered by rapid fluctuations, as long as it is upward! Unfortunately, we cannot always count on the market to be so accommodating. Perhaps a more appropriate description of risk for individuals would include "permanent loss of capital" as part of the definition." A man named Earnest Staby (one of the pioneers in the Point & Figure method of technical analysis) was thinking about measuring market risk back in the mid 1940s. He realized that traditional bar, Point & Figure, line graphs or the like were ineffective in determining market tops and market bottoms. It was his feeling that at market tops, these charts look the absolute best and conversely at market bottoms these charts look the absolute worst. He realized that what was needed was some sort of soulless barometer that would become negative at market tops and positive at market bottoms. A contrary indicator that would afford the investor the ability to become less aggressive as the market reached high risk levels and more aggressive when the market reached low risk levels. It took until 1955 for this indicator to be developed. In 1955, A. W. Cohen introduced the New York Stock Exchange Bullish Percent Index.

The Point & Figure Method

The NYSE Bullish Percent Index is simply a compilation of the percent of stocks on the NYSE that are on Point & Figure buy signals. The beauty of this method of analysis is that clear buy and sell signals are generated on the individual stock charts. These signals can then be tabulated and evaluated versus the total number of stocks underlying the index. The Point & Figure method was created by Charles Dow (the first editor of the Wall Street Journal) as a simple, logical, organized way of recording the imbalances between supply and demand. In the end, it is the imbalance that causes all stock prices to move, and nothing else. If there are more buyers in a particular stock than sellers who want to sell, then the price will rise. Conversely, if there are more sellers in a particular stock than buyers willing to buy, then the price will decline. If buying and selling are equal then the price will remain the same. There is nothing else. These same forces cause prices to change in the supermarket or anywhere you turn on this globe. The charts are made up of X's (stock rising in price) and O's (stock declining in price). Buy signals are given when a column of X's exceed a previous column of X's, and sell signals are given when a column of O's exceed a previous column of O's. The following boxes illustrate the most simple double top and double bottom patterns. One would simply add up all the stocks that were on buy signals underlying the NYSE and then divide by the total to get a Bullish Percent. Let's say there are 2000 stocks underlying the NYSE and 1000 of those stocks are on buy signals, then the NYSE Bullish Percent would be at 50 percent.

The chart of the NYSE Bullish Percent runs vertically from zero to 100 percent. We look at this as our football indicator because when the index is in a column of X's, we have the football. When the index is in a column of O's, the market has the ball. The key is how the index shifts from one column to the other, either X to O or O to X. It takes a six percent (each box on the chart equals two percent) net change to shift columns. For instance, a week's market activity produced 120 new buy signals and there were 160 new sell signals, and the index is currently in a column of O's. If we net out 160 sells and 120 buys we have a net change of 40 new sells. Divide 40 by 2000 and you get two percent or one box change this week. Therefore, if the index was in a column of O's, and each box represents two percent, the index would decline one box. In the case of a rising market, the opposite would take place. Once again, it takes a net six percent change to shift columns-or in the football vernacular-it takes six percent to either lose or gain the football depending on which way the shift takes place.

We play offense (buy stocks) when we have the ball, and we play defense (protect what we have) when the market has the ball. We look at the chart's scale as the football field. Where the index "is" on the chart (field position) is very important, too. We consider above 70 percent as a high risk level and below 30 percent a low risk level. Let's see why. When there are more than 70 percent of the stocks underlying the NYSE on Point & Figure buy signals there are no disconcerted investors; just about everyone is making money and the newspapers are as bullish as can be. Earnings estimates are coming in on the money like clockwork. It is also the point where everyone is in that wants to be in. If a broker called his client with a new recommendation for a stock purchase, the investor's response might be "I love the idea, what stock should I sell to get the money to buy it?" He's already in the market and has no funds to create new demand for this new idea. He is in a situation where he must create supply to have the liquidity to create demand. The net of selling to buy is a wash concerning supply & demand.

The other side of the chart presents opportunity and is found below 30 percent. When there are less than 30 percent of the stocks underlying the NYSE on a Point & Figure buy configuration, everyone is out of the market that wants to be out. The availability of supply to force the market lower is very low at this point. This presents opportunities for buying stocks, while the level above 70 percent presents opportunity to hedge or exercise more caution. One would not want to buy stocks with unbridled enthusiasm at a Bullish Percent reading of 76 percent. Conversely, the probability of loss is low at a Bullish Percent reading of 26 percent. What this index does is help investors to become defensive when the market is high and become more offensive when the market is low.

The Six Degrees of Risk

Earl Blumenthal added a dimension to this index that A. W. Cohen did not have. Blumenthal added six levels of risk that further provides guidance for the investor when using the Bullish Percent concept. Let's take a look at these risk levels.

Bull Alert-This risk level can only happen when the index is below 30 percent and reverses up (see above for how the index shifts from one column to the other). This is the most bullish risk level as it can only take place from below the 30 percent level. We call this a green traffic light.

Bull Confirmed-This risk level comes into play when the index is in a column of X's (you have the ball) and rises to exceed a previous column of X's. Field position is very important in this risk level as Bull Confirmed at 70 percent is much less positive than Bull Confirmed at 30 percent. We call this a green traffic light.

Bull Correction-This is simply a reversal into a column of O's (you lose the ball) from a column of X's, and this reversal must come from below the 70 percent level. It is generally short-lived and an opportunity to buy stocks on pullbacks. We call this a yellow traffic light.

Bear Alert-This risk level can only happen from above 70 percent. A reversal from above to below 70 percent (remember a reversal changes columns) will change the risk level to Bear Alert. You have lost the ball and defense is the order of the day. Defense can come in many fashions, like put hedging or setting stops, or simply buying less stocks. The decision belongs to the manager of the portfolio to determine what defense means to him. We call this a red traffic light.

Bear Correction-The exact opposite of Bull Correction. It is a reversal up from Bear Confirmed, signaling a breather from the recent decline in prices. It is generally short-lived and must come from above the 30 percent level. Traders can buy stocks for trading purposes or short sellers can plan to sell short negative stocks on bounces to resistance. We call this a flashing red traffic light.

Bear Confirmed-This is the exact opposite of the Bull Confirmed risk level, however, Bear Confirmed is a condition where a column of O's exceeds a previous column of O's. Like the Bull Confirmed risk level, field position is very important. Bear Confirmed at 30 percent is much different from Bear Confirmed at 70 percent.

After using this index as the backbone of our business, I am totally convinced nothing comes close to providing the guidance this index does. It's not a market predictor, simply a very good gauge of the prevailing risk. When the risk is high we choose to become less offensive. When the risk is low we choose to become more offensive. In many cases, the truth lies somewhere in between. A great adjunct to the NYSE Bullish Percent are the 40 Bullish Percent Indexes on sectors we follow. The NYSE Bullish Percent Index allows one to become a great caboose on the market train. We'll leave the predicting to others.


Thomas J. Dorsey is one of the founders of Dorsey, Wright & Associates, an independent and privately owned registered investment advisory firm with the expressed purpose of providing quality equity analysis based on the Point & Figure method of technical analysis. He has extensive experience in the equity markets, particularly in the field of risk management for which he is known internationally. He conducts risk management seminars across the world for industry professionals as well as individual investors. He has written numerous articles on equity market and options analysis for such publications as The Wall Street Journal, Barron's, Technical Analysis of Stocks and Commodities magazine, and Futures magazine. He is also a regular on CNBC.

Mr. Dorsey is the author of Point & Figure Charting: The Essential Application for Forecasting and Tracking Market Prices. To order Tom Dorsey's book or receive a FREE trial of our research, visit our web site at www.dorseywright.com.


CRB TRADER is published bi-monthly by Commodity Research Bureau, 209 West Jackson Boulevard, 2nd Floor, Chicago, IL 60606. Copyright © 1934 - 2002 CRB. All rights reserved. Reproduction in any manner, without consent is prohibited. CRB believes the information contained in articles appearing in CRB TRADER is reliable and every effort is made to assure accuracy. Publisher disclaims responsibility for facts and opinions contained herein.

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