Indices are the spine of investing and trading. The Dow, the S&P 500, Nasdaq, FTSE, Dax and Cac are this scores we looked to first to judge how goes it with the markets.
Indices are part of a tightly bound market causation that links equities, with futures, options, Forex and bonds. A move in one corner will move the price in what seems like an utterly unconnected stock. All sorts of subtle factors push and pull the markets from trades of fabulously obstruse factors that the everyday investor has no idea about. Events in far away places you may never hear about will affect the market for purely technical reasons. As so many markets are interlinked the equity indices contain a snap shot of all these action and that action is in effect random noise. This pitter patter of noise or sometimes hurricane howl of noise blurs the picture of the trend in the market. This ruins them as a clear indicator of the trend and what is going on.
So what is needed is a index with a low signal to noise ratio, a chart that shows what is going on in for example stocks without all the pollution of noise being injected by global market correlations.
In the UK for me this is the small cap index. There is no option for it, no futures, not liquid ETF and the stocks are small and expensive to trade in and out.
Here is a chart comparing the FTSE 100 and the Small cap index and you can see the fat volatility of the global index and the lower lever of ‘noise’ in the small caps.
Overall the small caps are telling the same story as the big caps when it comes to the markets trend and health but offers a denoised view that isn’t a smoothing of some technical average or filter.
Thjs might seem interesting but what is it tellingus now.
If you look at the above chart, the FTSE might be still making a base, its current low is high the the bases low. The Small Cap, less noisy chart has the market breaking down.
Looking at this chart, you would rightly feel that the market needs to rally quick or it will likely plummet as much as 10% which would put the UK market close to crash territory.
For me the UK is a market ‘canary in a coal mine.’
Now look at this chart it’s the canary against the Dow.
Markets are connected, and we should be very careful in the days ahead to check the canary hasn’t fallen off its perch.