There are three basic approaches to the market. One is to trade the market using a mechanical trading system. That is system that tells you exactly when to buy and sell. The second way is to use an analysis and judgment approach to determine when to buy and sell. The third way is to use a valuation approach to picking investments to be bought and hold until they become fully valued. This approach is often based on PE or PD ratios.

This site offers two of the three above approaches. The Market Barometers provide a mechanical approach with three different levels of aggressiveness. The Planning for Trading document in the Finance section provides an approach to making judgments for your self. The market indicators provided on this site can be helpful in analyzing the market for your self. The indicators are explained below.

Obviously, one can use one or the other or both approaches. If you do the latter, you should treat each separately from the other and have separate pools of capital for each approach.

Introduction to the Market Barometers:

There are three Market Barometer signals. The Conservative MB is invested only about 10% of the time.The Moderate MB is invested about 60% of the time. The Aggressive MB is invested about 80% of the time. There are trading result history files linked to each MB's name above. The back-tests for these signals use the NDX without leverage. However, the Market Barometer can be used as a trading system for the S&P 500 Index (SPX) and the Russell 2000 Index of small cap stocks (RUT) as well as the Over-the-Counter 100 (NDX). How to use the signals is described below.

The test models apply asignal given on one day to the indicated transaction at the close on next day. Thus, a signal that occurs on Monday evening is executed on Tuesday. The signals posted above are given as Long, Short or Neutral.  A neutral signal simply means that the model is neither bullish nor bearish. Cautious traders should probably sell on neutral signals.

Trades should be done using index-tracking funds. For example, there are ETF* funds that track the SPX (SPY long and SH short) and the NDX (QQQQ long and PSQ short), which are beta one or non leveraged funds. These are funds that can be bought and sold through a brokerage account, at any time during the trading day, like a stock and with no minimum holding period. Unlike mutual funds, ETFs will also allow you to set orders for automatic execution. The systems can be made more aggressive by using beta two or leveraged ETF tracking funds, e.g. SSO or QLD for long positions and SDS or QID for short positions.

Test results on the Market Barometers are based on being fully invested during each trade. In practice, I do not recommend this highly aggressive approach. See Money Management at the end of this document.

Explanation of Indicators:

The following is how I evaluate the broader market conditions. First, I determine the secular (very long term) cycle for stocks. Secular bull and bear cycles usually take years to play out and are based on the cycle of PE ratio expansions and contractions. It is customary to see significant bull trends develop within the context of a secular bear market and significant bear trends to develop within the context of a secular bull market. Thus, the trip is never straight up or down. Second,I use a moving average of monthly Wilshire 5000 data as a long-term trend indicator. These indicators are provided in the Indicators link and are updated each week, if they change. I have a moving average of weekly Wilshire 5000 data as an intermediate-term trend indicator. There is also a short-term trend indicator based on Wilshire 5000 daily data and a relative strength indicator(RSI) based on Wilshire 5000 daily data. Intermediate trend indicators are also provided on several other indexes such as gold, oil, bonds and so on.  

 In addition, I look at a volume related indicator that is the ratio of the volume on the NYSE and the OTC. When volume on the OTC out paces volume on the NYSE it suggests that there is more activity by speculators than investors. When this indicator favors investors, it is bullish for the market. Along with volume I follow another indicator based on long-term government bond prices. When this indicator shows money moving out of bonds, the implication is that it is moving into stocks or being positioned to move into stocks. I use these two indicators together to give a combined signal. The results for the combined signal for each of three indexes is available by positioning your cursor over the cell in column A labeled "Signal" in the Indicator table linked above.

Money Management:

You should always hold back a portion of your capital to ensure against a catastrophe that might otherwise wipe out your trading capital. Extreme events do happen now and then and can devastate the unwary.

To illustrate, in a simple approach to money management, one might set aside a specific sum of money for a trading system, for example, $50,000. Begin by placing half ($25,000) of the capital into the first trade. Assume a $5,000 profit on the first trade, which yields a total of $55,000. Thus, the next trade would invest $27,500. If there had been a loss of $5,000 on the first trade, the next trade would invest $22,500.

A more conservative approach would be to initiate trading in the above example with less than 50%. Use a stop loss order to protect one’s invested capital. For example, a stop loss order might be set to sell if the price drops 10% below the entry price or whatever you're willing to risk.

Money management in trading is a fairly complex task that involves considerations beyond the simple examples given above. In practice I use a system for managing trading capital and trades that is fairly complex and includes position sizing, progressive stop loss criteria and progressive take profit criteria. (See Money Management and Planning for Trading:  Click here for details). 

* ETFs (exchange traded funds) from ProShares are available through brokerage accounts. Comparable mutual funds are available through the Rydex family of funds.