The consistency of human behavior relative to a market move is key to understanding the environment. The type of participants in each market determines each market’s unique distribution of returns. The size of the returns is specific to the environment at any point in time and it is the repetitive accumulation of these returns at specific volatility thresholds that I believe can be used not only to measure momentum but also extremes in sentiment. Converting them to a binary form gives a clearer picture of the environment. The Thomas Counts is the binary translator of returns which accumulates them, separates the positive from the negatives, and then adjusts the counts for the distribution of returns for the market.
The TCs are subject to interpretation but in general above/below the mid-band separates risk on/off environments. These counts first behave as a momentum thrust (both positive and negative) and then dissipate and morph into an after-the-fact-here-was-the-extreme in positive/negative sentiment. Prices usually have some gas left in the tank when at extremes (identical levels for both positive and negative extremes) even if the thrust eventually fails and divergences between the counts and price show up. The counts can be used in any time frame allowing the user a fairly accurate interpretation of the environment thus eliminating the need for the always counterproductive practice of market timing. Forecasting the counts is as bad an idea as forecasting the price.
The counts (lower clip) in all my charts have 2 colors (usually blue is risk-on and red is risk-off.) There are also 2 colors on the upper clip (usually green for long and black for flat.) These L/N signals come from proprietary models specific to each market and do not always match the colors in the lower clip. These models don’t use the sophistication needed to trade but they are good enough as a first step when making a trading plan.
I believe these counts can be useful in answering the always difficult question in trading of when to exit a profitable trade when especially when using systems that traffic in asymmetrical returns.
The chart below shows the Thomas Counts for the SP500 (1928 - now.)
The Thomas Counts on AAPL.
