3 Simple Strategies for How to Use the New Highs/Lows Ratio when Day Trading
The new High new Low ratio is a technical indicator that is very simple. It measures the number of securities trading on the New York Stock Exchange (NYSE) which have hit a 52-week high and counts the number of securities that have hit a 52-week low. The new high and low indicator counts all securities listed, including stocks, preferred stocks, closed end funds and ETF's.
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Traders and investors have used the new highs and new lows indicator to gauge the market sentiment. Broadly speaking, the higher the number of stocks reaching a new 52-week high, the larger the market advances are which is assumed to occur on a wide range of issues that spurred investors into the bullish mode.
Similarly, when the count of the new high stocks starts to fall but you see that the stock index is still making highs, it indicates that only a few stocks are participating in this rally. Therefore this divergence offers a sign of an impending declining.
From a day trader or a technical trader perspective, the new high and new low indicator or new high/low ratio indicator is akin to using a technical oscillator on the chart and comparing it to price. For example, the RSI, which is based on the price, is a useful indicator to signal divergence in the security.
Under normal circumstances, the prevailing theory is that price and its oscillator (or in the context of this article, the new high/ new low indicator) must converge at all times. So when a security is at a high, the oscillator or the RSI must also confirm this by posting a high, same when the security posts a low, the RSI must also post a low.
A divergence is said to occur when either the security or the oscillator do not conform to each other.
The chart below shows a simple illustration of the convergence and divergence between a security and an indicator. This same principle is applied to the stock markets as well. The only difference here being that, one could use the major stock market index such as the Dow Jones or the S&P500 and compare it to the new high new low indicator to get an idea if the new highs in the index are as a result of broader stock market strength or if the rally to new highs was based on just a few stocks in the market.
While convergence will tell you that the new highs or lows are a result of broader participation, divergence can be a powerful tool as it can point you to potential weakness. When a new 52-week high in a stock index fails to be confirmed by the broader stock market, by means of using the new high new log indicator, it is a warning to investors to be careful when taking on new positions.
What is the new high new low ratio indicator?
The new high new low ratio indicator or NH/NL Ratio for short as explained earlier is a ratio of the number of stocks making a 52-week high and the number of stocks making a 52-week low. This indicator visualizes this phenomenon and can be useful for the stock trader to understand the relationship of the stocks that are making new highs and lows. A higher reading in the NH/NL ratio indicator means that more stocks are participating in the rally.
The calculation, as you might have guessed by now is very simple.
The new highs and new lows indicator is published on a weekly basis at any major financial website. The general rule of thumb is:
- the market is positive when the NH/NL ratio is biased to the upside. Ex: 400 new highs to 45 new lows
- the market is negative when the NH/NL ratio is biased to the downside. Ex: 40 new highs to 350 new lows
- the market is churning or is split if the NH/NL ratio is even. Ex: 400 new highs and 400 new lows
The picture below shows the weekly number of new highs and new lows across the different exchanges, published by Barrons (click here to access).
As an example, the above data for the week ending 23rd February 2017 shows 403 Nasdaq stocks making a new 52-week high against 36 Nasdaq stocks making a 52-week low. The NH/NL ratio in this case happens to be 11.19.
Applying this to the Nasdaq composite index you can see that the ratio if highs and lows coincides with the high in the index, thus implying that the stock markets are rallying on a broad participation of stocks.
The new highs and new lows indicator goes by different names, depending on the website, and the charting platform that you use. For example, stockcharts.com a site well known among stock market technical analysis calls the new highs new lows indicator as the High-Low index. The name may be different, but it is the same. The index measures the stocks posting a 52-week high and a 52-week low. The high low index is an advanced version which is a 10-day average of the record high percent.
The record high percent is nothing but dividing the number of stocks making a 52-week high by the sum of all stocks making a 52-week high and a 52-week low.
For example, if you look back at the previous data for Nasdaq, (403 NH and 36 NL), then the record high percent is 403/(403+36) which is 0.917 or 91.7%.
The chart below shows the S&P500 stock chart with the SPX HI-LO indicator shown below. The indicator show the extremes, which when coinciding with the peaks and troughs in the index can be used as a powerful way to pick tops and bottoms.
Strategies to use the new high new low indicator
The new high new low indicator is primarily used as an indicator to measure the market breadth and to validate the highs or the lows in key benchmark stock indexes. Therefore, in terms of the strategies available, the best use of the new high new low indicator is suited trading the stock index futures or ETF’s.
Here are three ways on how traders can use the new high new low indicator in their trading.
1. Timing the markets
The most obvious strategy that can be applicable to traders, regardless of whether one is a swing trader or a day trader is to look at the new high new low indicator to time the markets. Because the indicator tracks the components of the exchange, it is best used on an index such as the Nasdaq or the S&P500.
By using the new high new low indicator, traders can look to buying into the ETF or a futures contract when the new high new low indicator is above 50. Alongside this confirmation indicator, traders can also look at applying a 10-day moving average to the chart as well as a second confirmation. Finally, looking to the price action itself such as the candlestick pattern or a chart pattern such as bullish flags or pennants can help to bring more validity to the outlook.
The chart below shows the SPX applied with the 10-day simple moving average with the new high new low indicator. In the region marked, you can see that the indicator is above 50, and this is later confirmed by price trading above the 10-day moving average.
It is up to the trader from here on as to whether they want to hold their position over a period of time or to book profits if they are trading futures. In this example, the focus is not to confirm whether the market high is validated by large number of stocks making new 52-week highs, but to use the 50-level in the oscillator to see which way the market is biased.
A reading between 50 and 75 is a fairly good indicator that the market sentiment is bullish and thus traders can buy into the rally. The bullish bias is even better when validated by other indicators such as the moving averages.
2. Buying channel breakouts
Channel break outs, or specifically Donchian Channels are a great tool to add to one’s technical analysis arsenal when dealing with breakouts of any kind. Thus, the Donchian channel indicator makes for a great addition that compliments the new high new low indicator. The new high new low indicator can be used to validate the breakouts from the 20-day Donchian Channel high and can be used as simple way to trade the S&P500 index.
The chart below shows the 20-period Donchian Channel applied as an overlay on the chart and the new high new low indicator seen below the chart. The blue arrows shows potential levels where you would have been long.
With the Donchian channel strategy, the trading rules as simple. Buy when price breaks out above the 20-period high and the new high new low indicator is above 90. This value can of course be adjusted to 80 and it up to the trader’s discretion.
Once the new high new low indicator is above 90, in this example and price breaks above the 20-period Donchian channel, you can place a long position and hold until the new high new low indicator dips below 90. The first section shows a long position that was held from around 2180 on November 21 and the position was held until we got an exit trigger at 2240 around December 27, thus giving a neat 40 point move in the market.
Following, the red arrow shows the area where you would have remained on the sidelines as there was no breakout in the Donchian channel at the time the new high new low indicator was above 90 or vice versa. The more recent signal came around 12th or 13th of February with a long position at 2310 with the long position still held while the S&P500 is at 2363.81.
3. Divergence and moving average confirmation
The new high new low indicator can also be used as a divergence indicator to spot any discrepancies while also applying as a confirmation for a bullish moving average crossover. The next chart below shows the divergence as the Dow Jones Index falls to make a new low, but the new high new low indicator shows a higher low being formed. This is later followed up by the bullish moving average crossover and validated by the new high new low indicator above 50 and rising.
As you can see from the above, there are many different uses to the new high new low indicator. For traders who prefer to use the technical aspects of day trading, the new high new low indicator can inform the trader about the general market sentiment, thus keeping you on the right side.
The new high new low indicator goes by many different names and is usually not widely available on many charting platforms. Therefore, day traders need to research into the charting platforms where the new high new low indicator is available. In most cases, the data can be calculated manually via the weekly or daily information published from websites such as Barrons.
For all the information the new high new low indicator has to offer, traders should realize that this is applicable when looking at the broader stock markets. Thus, in terms of its uses and application, the new high new low indicator is best used to trade index futures or index ETF’s which offer a better gauge of the stock index and is liquid enough to day trade.