The stock market, like any market place, is driven by supply and demand. Knowing whether supply exceeds demand, or vice versa, can increase the odds of investment success.
That sounds easy, but here is the problem: At any given time, a stockâs price reflects how much investors are willing to pay right now.
How can you use current supply and demand data to predict future prices?
When looking at supply and demand (or liquidity) data, I try to discern if there is pent-up demand. Just as it takes boiling water to blow the lid off, it takes pent-up demand to propel prices higher (and often through technical resistance).
The execution (2011)
Example: The chart below plots the S&P 500 Index
Â (during the 2011 correction) against the percentage of advancing stocks on the New York Stock Exchange.
During the 2011 correction process (dashed green box), there were 13 days with more than 80% (green line) of stocks advancing.
Near the August and October 2011 low, we also saw four days with fewer than 10% of stocks advancing (which is equal to 90% down days, red line), usually a sign of selling exhaustion.
Under the hood, sellers started to throw in the towel, while buyers accumulated. Initially price remained range bound (as usually the case with internal strength), but eventually stocks broke out, and the rally from the October low was accompanied by increasing buying pressure (green arrow).
The 2011 example is shown, because this current correction was expected to follow a course similar to 2011. On Feb. 11, I wrote in the Profit Radar Report that:
âWhen boiling down all our indicators to a few sentences, we find that a bounce is probable. The bounce, however, may turn into a period of range-bound, up-and-down market action, not an immediate directional up move. A path similar to 2011 with a retest of the original panic low.â
What about 2018?
The chart below shows supply and demand during the 2018 correction. There were barely two 90% down days, and only one 80%-plus up day.
Money flow near the April low created a bullish divergence, but there was no follow through.
In short, sellers arenât capitulating and buyers arenât stepping up.
One or more 90% down days (indicating that weak hands have been flushed out) or 80%-90% up days (indicating buyers are stepping in) would increase the odds that stocks have bottomed.
Ideally, weâll see a combination of both â 90% down days followed by strong demand (like in 2011).
Of course, liquidity is only one of the factors that go into a comprehensive forecast. Other important factors are discussed in this S&P 500 forecast.
Simon Maierhofer is the founder of iSPYETF and publisher of the Profit Radar Report. He has appeared on CNBC and FOX News, and has been published in the Wall Street Journal, Barronâs, Forbes, Investors Business Daily and USA Today.