How to tell if a rally (or decline) will have legs

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How to tell if a rally (or decline) will have legs

“She's got legs, she knows how to use them.
She never begs, she knows how to choose them.
She's holdin' leg wonderin' how to feel them.
Would you get behind them if you could only find them?
She's my baby, she's my baby,
Yeah, it's alright.”

– ZZ Top

Have you ever wanted to determine if a rally is likely to have legs and keep increasing?

Or if a decline is going to keep getting worse?

Here’s how to do it.

First of all, you need to pull up four ETFs:

DIA (Dow Industrials), SPY (S&P 500), QQQ (NASDAQ 100), and IWM (Russell 2000)

I’ve listed these ETFs by increasing volatility.

DIA having the lowest volatility, and IWM the highest.

If all four of the percent gains are in order, then the market will likely continue to rally.

For example, let’s say that DIA is +0.8%, SPY is +1.1%, QQQ is +1.5%, and IWM is +2.0% on the day…

…It’s likely that stocks in general will continue higher.

However, if one or more of them gets out of whack, then the buying pressure is not in balance, and you’ll likely see chop.

The reverse is also true.

Take today for example.

As I write this, DIA is -1.1%, SPY is -1.2%, QQQ is -0.83%, and IWM is -1.74%.

QQQ is an outlier, so we’re probably going to see a choppy day.

Arming yourself with this kind of information is a great motivator for not dilly-dallying with getting into – or out of – your trades.

It's interesting to note that all four of these indices have underlying futures contracts.

The world is awash in derivatives.

Buffett calls them “weapons of mass destruction.”

Buffett urged congress back in 1982 not to allow index futures.

Indeed, the bulk of evidence points to an increase in volatility since index futures were introduced.

But hey, that's the world we live in.

Lucky for us, the CFTC started forcing futures participants to report their holdings back in the 60's.

So the infrastructure of reporting was already in place by the time index futures exploded in popularity.

Relative to the the stock market where billions of shares are traded each day, index futures in the emini S&P 500 only trade about 1.5 million.

Yet one guy, Navinder Sarao, managed to trigger the Flash Crash all by his lonesome — from the comforts of his bedroom — by sending illegal “spoofed” orders to the exchange.

If that doesn't make you worried about derivatives, then I don't know what will.

To learn about how “insiders” in this tiny market are controlling trillions worth of stocks, take a look at this 43-second clip >>

Trade smart,

Dan “Prince of Proof” Murphy