Leading and Lagging Indicators

By following my "Index Trading" post on July 10, 2010 where I wrote "In summary I would say that I see number of factors that favor further up-move." we basically saw positive trading at the beginning of this week.

Then in my "Increase in Volume" post on July 13, 2010 I stated "At this moment the majority indicators continue to be bullish and, personally, I would expect to see positive and sideway trading during this week." and then in my "Nasdaq 100" post I mentioned "Yet taking into account increase in volume I may expect a slow down of the current recovery, and at leas a side-way trading - then we may see how it develops.". As it happened, we had 2 trading sessions of side way trading (July 14-15, 2010) and then strong decline on the last day of the week (July 16, 2010).

Now, the main question is whether the stock market (Nasdaq 100, S&P 500 and DJI) indexes will continue their drop, or there could be other scenario. Below, I tried to summaries some points that on my opinion may help in understanding possibilities of further trend development.

1. The Friday's drop down was very strong. The Dow Jones Industrials dropped on that day by 2.8%. The stronger DJI bearish trading last time was seen on June 29, 2010 and on June 4, 2010.
2. The indexes were only two trading sessions in side-way trading at the top before that decline (June 14-15).
3. During that decline we had very strong oversold advance/decline readings (in both issues and in volume)
4. During that decline we had strong output of the bearish volume (very high trading volume).

All four points above would recommend that this is could be logical healthy drop down to release some overbought pressure collected over the 8 positive trading sessions in a row on the Nasdaq 100 ( 7 positive sessions on DJI) and now, even we could have some further decline the odds could be good that we may see indexes back to their June 13-15 high levels.

The Bearish points are:

1. Majority technical indicators show bearish signals.
2. Volatility is increasing.

Leading indicators (volume and advance decline based technical studies) signal that the stock market (indexes) is predisposed to bounce up. However, most of the lagging technical studies (price based indicators) are bearish.  The high volatility is very important factor on my point. Because of high volatility we may see strong and sudden changes in a trend when most of the technical indicators (due to a lag) would generate signals when it's too late to open/close position. High volatility also suggest that the market is still weak and even if we see bounce up, if the volatility does not go down, there will be a possibility of developing of another down-move.

Overall, by summarizing all of the above, I would say that if I would be in short, I would think about closing short position or at least about setting a stop-loss to protect profit. I would not rush into a long trade (majority of indicators are still bearish) and I would monitor index charts closely for possibility of changes in the sentiment toward bullish trading.