How would you answer the following question if I gave you just 10 seconds to do so?
“What’s the market doing right now?”
If you’re like most Americans, you would most likely cite the movement of the Dow Jones Industrial Average. Most people will say, for example, “the market” is up 100 points!
This is a horrible habit that you should break immediately – especially if want to become a solid technical trader.
The Dow Jones Industrial Average is just an index of 30 multinational and mostly mega-cap (more than $200 billion) blue chips. But people have been programmed by the media to use it as their primary indication of what’s happening in the stock market.
Consider how absurd that is. Due to the typical weighting structure of the major indexes, it’s possible for the Dow to show a gain of only 1%, even while 70% of the stocks in the market are up 10%. Significant strength or weakness is easily masked by major indexes.
If you start viewing the market as small caps, mid-caps, large caps and mega-caps, instead of as the Dow, you’ll have a clearer understanding of the stock market.
For example, stocks of smaller companies tend to lead the stocks of larger companies. If small cap stocks are showing significant weakness while large caps are still advancing but fizzling out, it might be a sign of trouble ahead.
When someone asks you what the market did today, a better reply is: “The market is up 1.5% to 3%, depending on the index you’re talking about.” Or ask them what part of the market they are talking about. If they look at you funny, or even laugh at you, you’ll know you’re on the right path.
Viewing Multiple Markets
Get in the habit of viewing multiple market indexes and understand how they are structured. It doesn’t take much time to do it.
Here’s an example of three very different indexes that are all very popular: the Dow, the S&P 500 and the Nasdaq 100.
As you can see in our first chart, the Dow has approximately 300 points to gain before it recovers everything it lost in the recent correction.
Our second chart shows that the S&P 500 finally recovered from the recent correction and broke a new high yesterday. Most investors celebrated that because the S&P 500 is an extremely popular benchmark.
Given that the Nasdaq 100 recovered nearly two weeks ago, I’d be more inclined to invest in it than in any other major market index. You’re probably familiar with the exchange-traded fund (ETF) that tracks the Nasdaq 100, the PowerShares QQQ Trust (Nasdaq: QQQ).
There are no financial stocks or energy stocks in the Nasdaq 100, and it’s very heavily weighted in tech stocks. The strength in the tech sector as well as the consumer discretionary sector (which is the Nasdaq 100?s second-biggest sector) does two things for us:
- Gives us a good understanding of where a bulk of the market strength lies.
- Gives us one easy security to own, QQQ, to get the most out of the bull market.
If you’re only focused on the Dow or the S&P 500 then you’re limiting yourself. Here are the indexes that you should start tracking as closely as the very popular Dow or S&P 500 (the symbols used are those you’ll find via Yahoo Finance):
- S&P 500 (^SPX), large caps.
- S&P 400 (^MID), mid-caps.
- S&P 400 (^SML), small caps.
- The Russell 3000 (^RUA): This index has 3,000 of the largest U.S. stocks that represent 98% of the publicly traded market. You might think this will give you the best picture of the entire publicly traded universe. However, the index is heavily weighted toward the large cap universe.
- The Russell 2000 (^RUT): This index is made up of the bottom 2,000 stocks in the Russell 3000. While it includes two-thirds of the stocks in the Russell 3000, it represents only about 10% the market capitalization of the broader index (or about 10% of the entire market). Keep in mind while this is the benchmark most small cap funds use, it’s actually made up of several mid-cap stocks too.
- The Russell 1000 (^RUI): You may have guessed already that this makes up the top one-third of the Russell 3000, representing 90% of the market capitalization of the broader index.
- The Russell 800 (^RMC): This represents the bottom 800 stocks of the Russell 1000, representing about one-third of its market capitalization.
- The Russell 200 (^RT200) and the Russell Top 50 (^RU50): These both represent mega-cap stocks. I follow the Russell Top 50. This is the top 50 largest market capitalized stocks representing about 40% of the market cap of all U.S. stocks.
View original at: Investment U
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