Dr. Alexander Elder describes the New High-New Low Index (NHNL) probably the best leading indicator of the stock market in his book Trading For A Living. It tracks the number of market leaders. It measures the difference between the new 52 week Highs (strength) and the new 52 week lows (weakness) made during the given day. NH-NL confirms trend when it rallies or falls in gear with the price. The construction of this index is very simple; all you need is the number of new 52 week Highs, and you subtract from it, the number of new 52 week Lows. This can than be plotted as a line or a histogram. The NHNL Index tracks the strongest and the weakest stocks in the exchange and compares their numbers. It measures the balance of power between the leaders in strength and leaders in weakness. This is what makes it a leading indicator and the broader SnP Index tends to follow it.
Elder further explains the trading rules with NHNL in order of their importance. They are Divergences (I just love this one!!!) between peaks and bottoms of NHNL and Price, the trend of NHNL, and finally the level of NHNL below or above its centerline. A brief outline of the above rules is given asunder:
1. If NHNL traces a lower peak while the price rallies to a new high it creates a bearish divergence. This means that the bullish leadership is weakening even though the broader market is high. It’s time to book profits, or at least tighten your stops.
2. If NHNL traces a shallow bottom while the price makes a new low it creates a bullish divergence. This shows the bearish leadership is sinking even though the broader market is low. This is the time to cover up shorts and look for confirmation in price to go long.
3. A rise in NHNL shows it is safe to hold to long positions or add to them. When NHNL declines while the broader market is flat or rallies its time to book profit on your short term long trades. It’s vice versa in case of short trades.
4. If it rises on a flat day, it flashes a bullish message and gives a buy signal. On the other hand if NHNL declines on a flat day, it flashes a bearish message and gives a short signal.
5. If NHNL stays negative for several months but then rallies above its centerline, it signals a new bull move is likely to begin. This is the time to look for opportunities to go long using oscillators for precise timing. The opposite holds true when NHNL after spending considerable time above its centerline falls below it.
For a more detailed explanation of the NHNL, I suggest reading of Dr. Alexander Elder’s book Trading For A Living.
Remember Always Wait For Confirmation From Price!!!