Bullish Percent Index can be based on P&F Charts or even a Line Chart
Introduction
If you are interested in market breadth indicators, which can also serve as a proxy for prevailing market sentiment, you may have come across the Bullish Percent Index (BPI). This indicator measures the percentage of stocks in an index that are on Point & Figure Buy Signals. It is a useful tool for gauging the overall strength and direction of the market, as well as identifying potential reversals and opportunities.
Point & Figure charts are a type of technical analysis that focus on price movements and ignore time and volume. They use X’s and O’s to represent rising and falling columns of prices. A stock is on a P&F Buy Signal when a column of X’s exceeds the previous column of X’s. Conversely, a stock is on a P&F Sell Signal when a column of O’s exceeds the previous column of O’s.
The Bullish Percent Index was developed by A. W. Cohen in the mid-1950s and originally applied to NYSE stocks. Cohen served as the inaugural editor of ChartCraft, a precursor to Investors Intelligence. Subsequently, enhancements to BPI signals were introduced by Earl Blumenthal during the mid-1970s, followed by additional refinements by Mike Burke in the early 1980s.
Credit: (1) Point and Figure Charting, by Thomas J. Dorsey (Wiley Trading Series); (2) Three-point Reversal Method of Point & Figure Stock Market Trading, by A. W. Cohen (Chartcraft, Inc.)
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Concept and Purpose
The BPI is designed to measure the percentage of stocks or securities within a specific market or index that are exhibiting bullish technical patterns.
It is primarily used to assess the overall health of a market. When a high percentage of stocks are in bullish patterns, it suggests a strong and healthy market, while a low percentage may indicate weakness or bearish sentiment.
Calculation of the Bullish Percent Index
The BPI is calculated by taking the number of securities within a specific group or market index that are currently exhibiting bullish technical patterns and dividing it by the total number of securities in that group.
Bullish technical patterns typically include buy signals from indicators like point-and-figure charts, moving averages, or relative strength indicators.
Interpreting the Bullish Percent Index
The BPI can range from 0 to 100, similar to a percentage.
A high value (approaching 100) generally indicates that most stocks in the index are on P&F Buy Signals, which implies bullish market conditions. A low value (approaching 0) indicates that most stocks are on P&F Sell Signals, which implies bearish market conditions.
Generally, the bulls have the edge when the BPI is above 50% and the bears have the edge when BPI is below 50%. However, there are also other signals that can be derived from BPI based on its trend and reversals.
Trends and Reversals
One of the key uses of the BPI is to identify trends and potential trend reversals. When the BPI is in an uptrend and consistently above 50, it suggests that the majority of securities in the group are in bullish patterns, indicating a strong bullish trend.
Conversely, when the BPI starts to decline and fall below 50, it may indicate weakening bullish sentiment and the potential for a trend reversal.
Confirmed Signals
One of the most common signals is the bull/bear confirmed signal. This occurs when BPI crosses above 70% or below 30%.
These thresholds mark overbought and oversold levels respectively. A cross above 70% confirms a bullish market and a cross below 30% confirms a bearish market.
The signal remains valid until BPI reverses by at least 6%, which is the minimum amount required for a column change on a P&F chart.
Alert Signals
Another signal is the bull/bear alert signal. This occurs when BPI reverses from above 70% and crosses into the 60s, or from below 30% and crosses into the 40s.
These reversals indicate that market conditions are changing and a new trend may be emerging.
A reversal from above 70% alerts to a possible bearish market and a reversal from below 30% alerts to a possible bullish market. The signal remains valid until BPI crosses back above 70% or below 30%.
Correction Signals
Another signal is the bull/bear correction signal. This occurs when BPI reverses from between 30% and 70%. These reversals indicate that market conditions are undergoing a correction within an existing trend.
A reversal from between 30% and 50% indicates a correction within a bearish market and a reversal from between 50% and 70% indicates a correction within a bullish market.
The signal remains valid until BPI crosses above 50% or below 50%.
Divergences
One of the most common ways to use the BPI is to look for divergences between the BPI and the price action of the market or sector.
A divergence occurs when the BPI moves in the opposite direction of the price, signaling a possible change in trend. For example, if the market is making new highs but the BPI is making lower highs, this indicates that fewer stocks are participating in the rally and that the market may be losing momentum.
Conversely, if the market is making new lows but the BPI is making higher lows, this indicates that more stocks are showing strength and that the market may be bottoming out.
Overbought or Oversold Conditions
Another way to use the BPI is to look for extreme readings that indicate overbought or oversold conditions.
Typically, a BPI above 70 or below 30 is considered extreme and suggests that the market or sector may be due for a correction or a bounce. However, these levels are not fixed and may vary depending on the historical behavior of the BPI.
For example, some markets or sectors may rarely reach above 80 or below 20, while others may frequently oscillate between 90 and 10. Therefore, it is important to analyze the BPI in context and compare it with its previous highs and lows.
Moving Averages
Yet another way to use the BPI is to look for signals based on its moving averages. The moving averages can help smooth out the fluctuations of the BPI and provide more reliable indications of trend changes and entry points.
For example, some traders may use a crossover of the BPI and its 10-day moving average as a buy or sell signal, depending on whether the BPI crosses above or below its average. Others may use a combination of two moving averages, such as a 20-day and a 50-day moving average, and look for crossovers or confirmations between them.
Application
The BPI is not limited to analyzing broad stock markets; it can also be applied to specific sectors, industries, or even individual stock portfolios.
Traders often use the BPI in conjunction with other technical indicators to make informed trading decisions and manage risk.
Risk Management
Traders often use the BPI to make informed decisions about portfolio allocation and risk management. For instance, if the BPI is in overbought territory, it might be a good time to reduce exposure to that market or sector to mitigate potential losses.
Confirmation Tool
The BPI is most effective when used in conjunction with other technical analysis tools and indicators. It can be used to confirm signals generated by other indicators or to provide a broader context for a trading decision.
Watch for Extreme Readings
Extreme readings, such as a BPI above 90 or below 10, are often seen as warning signs. They suggest that the market may be at an unsustainable level and could be due for a significant reversal.
Periodic Analysis
It’s important to regularly analyze the BPI, as market sentiment can change quickly. Weekly or monthly updates are common.
Limitations
Like any technical analysis tool, the BPI has limitations. It relies on historical price data and patterns and does not consider fundamental factors.
It’s important to use the BPI in conjunction with other forms of analysis to avoid making trading decisions solely based on this indicator.
The Bullish Percent Index (BPI) is a very useful indicator that can help traders identify the overall sentiment and direction of the market or sector, as well as spot potential reversals and opportunities. By using P&F charts, it eliminates noise and ambiguity and provides clear signals based on price action. However, like any indicator, it should not be used in isolation but in conjunction with other tools and analytical factors such as price action, volume, support and resistance levels, and fundamental analysis. By using the BPI wisely and appropriately, traders can gain an edge in trading the markets.