How To Determine Market Health

Updated: Nov 19

5 Tools to help you assess the stock market environment.

Traders make most of their money in an easy dollar environment when the markets are supportive. The key thereafter is to preserve profits in volatile and choppy markets.

If the drawdowns take away most of your profits, you would not be too different than a buy-and-hold investor. In that case, devoting time and effort to trading is a worthless exercise.

Therefore, it’s essential to understand the health of the market and adapt the trading strategy to different market conditions.

My personal strategy for example, by default adapts to poor market conditions by reducing positions size, reducing the number of positions, and descaling from any use of leverage.

There are however several tools to assess the health of the market. Some of them also deliver warning signals or signals of strength that aren’t clearly visible in the index or talked about in the news.

Here are five such tools that you can use to assess the health of the market.

Index Technicals

The most basic indicator of market health is the technical setup of the index. This includes candlestick analysis, price-volume action, stage of the trend as per the Dow Theory, price behaviour toward trendlines and moving averages, and the state of indicators like the relative strength index (RSI) and the moving average convergence divergence (MACD - My Favourite).

Most indicators are laggards and show weakness or strength when most of the action has already happened. Therefore, you should be proactive and skilled in interpreting the indicators. If you wait for the indicator to confirm the state of the market, you could be too late in acting.

The best way to deal with the conundrum is to choose the least lagging indicators like candlesticks, price volume and support/resistance lines which often lead the health check of the market. Once these indicators flash warnings signs, exercise caution while keeping an eye on other indicators.

As the weakness starts appearing in other indicators, you would know that it’s time to preserve profits and be less aggressive.

Although my Trading approach reacts by default I do look for some technical aspects for my longer term Index positions, for example a recent S&P chart I posted in our group shows potential support off the 50 week moving average, this could be a good time to add some positions, or equally if price breaks through that support, it could be a sign to be very cautious.

S&P 500

Net new highs / new lows