Why Are Market Index So Important?
Major Market Indices like S&P 500, NASDAQ, FTSE 100, Dow Jones, Nikkei 225, Nifty 50 and other are barometers of the mood of general market in that exchange or country itself. The stock market index trend is important for traders and investors because it leads the whole market in bull or bear market. So it is very important to keep an eye on the major market index while trading. Because it is the major factor that affects your final result.
“Most part of your profit or loss in stock market investments depend on the performance of general market index, less on performance of individual stocks”
Is Market Index And Stock Analysis Different?
A market index is not a real stock because it hasn’t and P&L statements, balance sheet neither there is any company in the name of the index. It is just a derivative result from the formula which consists of stock prices of major corporations listed on the exchange.
Market indices are more liquid than stocks because it consists of most liquid stocks in exchange.
Indices are less volatile than stock because it consists of less volatile stocks in exchange.
Market indices have large volumes because it consists of high volume stocks in exchange.
All these factors make the analysis of market index trend requiring special attention than of common stocks.
A Unique Indicator For Market Index Trend Analysis
Though we can use conventional trend line, trend channel for analysis of market index, there is an indicator which is more suitable for representing the health of market index trend. This indicator is On Balance Volume (OBV). This indicator is compared with price line chart for measuring the market index trend.
“If the price and OBV indicator are going in synchronization than the ongoing trend is healthy and it is more likely to continue.”
This can be seen in the following chart:
In the above chart at point 1, there is a small divergence between price and indicator which suggest the change in trend. Before point 1 trend was sideways that changed to up, as the divergence was small the resulting reversal was also very small.
At point 2 price is going down while indicator was going up. This is a negative divergence between price and OBV indicator. So the resulting trend was down.
Between point 2 and 3, both price and OBV is going down in synchronization. So this down trend is healthy until point 3.
At point 3 the price is going up while the OBV is going sideways, this is positive divergence. So now the index moves higher.
Thus using this divergence we can predict market index trend reversal in advance and also the healthy market trend. The following is the example of positive divergence in Dow Jones Index.
Most Powerful Reversal Pattern: Double Divergence
When the market is at major reversal points like major top or bottom, we can frequently find an important pattern of reversal. This powerful pattern is called double divergence. In double divergence, the intermediate price tops and bottoms reveal remarkable desynchronization with OBV at the same points.
This can be easily understood using following examples of Nifty 50 and S&P 500.
You can also understand this concept more easily using this video.
Thus double divergence is powerful tools to predict any market trend reversal. OBV is a powerful indicator to check the health of ongoing market trend.