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I talk a lot about how to manage your emotions so you make good trading decisions. Today, let’s focus on how to trade using market internals.

Market internals are the key to understanding overall market performance and sentiment. You’d think that everyone would look to internals for guidance, but nope. Far too many traders try to refuse to see what is truly happening in markets. They prefer to let their biases control their decisions. Eventually, the emotions start becoming a problem.

You can’t control the markets anymore than you can control the weather. If you are bullish stocks and believe market trends and seasonal factors are in favor of an upward run, great – as long as the internals are aligned with your viewpoint.

And if they’re not aligned? Turn to indicators that provide real-time information on market conditions and sentiment. Be flexible and adapt to the actual – not hoped-for – environment.

How to trade using market internals

Start with breadth, which tells you whether the number of issues that are up vs down (and vice versa). If more issues are down, the market is bearish. If more issues are up, the market is bullish. It is not more complicated than this.

You can also view breadth against volume. This tells you how committed big institutions are in equities. The higher the volume, the more money is piling into stocks – a strong bullish signal.

Next, look at the volatility index (VIX). When this indicator is falling, the markets tend to be bullish. When it is rising, fear is taking hold and markets tend to go lower. The logic is simple: Less fear means investors can be more aggressive (and vice versa).

Lastly, we have the put/call ratio. This sentiment indicator tells us where money is flowing in the short-term. If traders are buying more puts, it means they are nervous about a future decline in the markets. If stocks are rising into a high put/call reading, it’s a red flag that stock prices are too high.

Using the internals to guide your trading makes sure you’re on the right side of the trade. There won’t be guaranteed moves every time, of course. Just remember this: If price is rising and these three indicators are poor, use caution.

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