DOW vs BoP

In this section we’ll look at another DOW relationship, but this time with the Balance of Power (BoP).

The DOW/S&P and Nasdaq are inversely correlated to Flow. However, the BoP is positively correlated to the indexes and gives us additional insights into price action. The chart below provides us with some information not available in other indicators (MT or not).

To understand the chart better let’s talk a little about how it was constructed. The BoP is assigned ‘+1’ for each cell filled in. The maximum bullish net is +6, the net bearish total cannot be lower than -6. It can’t exceed these levels and so we have ‘upper’ and ‘lower’ boundaries we can use to help us identify peaks, divergences, basing and support areas and trends.

We take the total filled-in bullish BoP cells minus the total filled-in bearish BoP cells to get the net total for the day and use that net amount to plot on the chart along with the DOW:

There are three helpful patterns we identified in this relationship to help us with market timing.

First ‘divergences’ (#1) are a pattern we saw often on the chart and in our historical data. At the far left of the chart you see the DOW rising from the 24750 area to just above 26500 from Jan 4th to Jan 26th. At the same time we see the net bullish BoP decline from approx. +5 to +1.

This divergence setup one of the best shorting opportunity in years. The DOW declined approx. 2500 points in 10 days.

The second pattern we identified is when we reach a ‘peak’ (#2) in the net values from +6 to -6. When the BoP total is +6 it means that there’s so much bullishness that there’s not likely to be any more bulls willing or able to help the market move higher – everyone is already on board. When the BoP total is -6 it’s not likely any more bears will join the move lower – everyone who wants to be is already on board.

The third pattern we see is ‘basing’ (#3). We see basing primary when the market declines and ‘peaks’ and ‘divergences’ at the top of market swings.

On the chart above ‘basing’ is easy to see. The net levels on the BoP find a support level and typically will decline to the same level twice or more times before launching a swing rally.