I don’t know what just happened in Russia. All I know is that as events unfolded, I was left with the same feeling of bewilderment I would get when I used to fall for those click-bait online adds which feature the words “weird trick.” On the other hand, I was relieved, while simultaneously realizing the world is in a precarious situation.

Indeed, recent events in Russia should serve as a reminder that we are living at what scientists call the Edge of Chaos, where events are so unpredictable that there is little point in trying to forecast outcomes. As a result, investors should prepare for as many possibilities as plausible and adjust their portfolios accordingly.

Incidentally, if you’re looking for a great treatise on the emerging discipline of Complexity which grew out of Chaos Theory, I recommend Mitchell Waldrop’s 1992 book, Complexity: The Emerging Science at The Edge of Order. For me, it was a life changer.

Here is what I learned from Waldrop’s book, boiled down to its most basic tenets. Complex systems, such as economies, countries, and populations, function based on the ebb and flow of events between two extremes; Chaos (disorder) and Complexity (the daily non-linear, but mostly orderly interaction between all the players in the system and the environment).

The dividing line between the two is known as the Edge of Chaos. This is where the parts of the system become super charged and eventually emerge to a new level of Complex functioning. It’s similar to what happens in a video game when you move to the next level.

Systems can emerge into new levels of Complexity or fall into Chaos. Eventually, Complexity returns and some sort of new non-linear order is established.

What we saw in Russia over the weekend was essentially a move toward the bottom border of the Edge of Chaos. Had the system fallen into Chaos, I would likely be writing a different article.

That said, all complex systems behave similarly. And it so happens that the stock market is a superb example of such a system.

Gauging The Complex System Known as The Stock Market

Over the years, I’ve settled on one indicator as the best measure of the action in the stock market: the New York Stock Exchange Advance Decline line (NYAD). That’s because when the majority of stocks are advancing, the line moves higher and when the decliners outnumber the advancers, the line falls.

Of course, a rising line means the stock market is in an uptrend, while the opposite is true when the line is falling.

By adapting common technical indicators to NYAD, I can tell when the markets are reaching important support (levels where a bottom is likely to form) or resistance (points at which a top may form). I use the 20-day, the 50-day, and the 200-day moving averages to define short, intermediate, and long-term support and resistance levels.

The moving averages are akin to “edges” of Chaos in terms of the market’s trend. As long as NYAD is above these moving averages, it is functioning in “complex” territory (bullish). When the line breaks below these important dynamic trend lines, the trend is moving into Chaos.

Moreover, I use Bollinger Bands (BB- the outer flexible bands above and below the prices) as indicators of whether a trend has gone too far and a reversal is possible. In other words, when prices fall below the lower BB, the line and the market are likely to bounce. The opposite is true when the line rises above the upper band.

I also review the CBOE Volatility Index (VIX) and the Eurodollar Index (XED) in combination with the NYAD. VIX is a good measure of volatility. Generally lower VIX readings are bullish while higher readings are bearish. XED measures how much money is available to trade stocks. Rising XED is usually a bullish indicator, because it signals that interest rates are falling.

Finally, I use the Relative Strength Indicator (RSI) to confirm the overbought or oversold status of the market via its relationship to NYAD. When RSI rises above 70, NYAD is overbought. This means the line may pause or reverse. This signal is doubly meaningful when it occurs in close proximity to a break above the upper Bollinger Band.

When RSI falls to 30 or below, NYAD is oversold and the opposite is true.

What The Action in NYAD Tells Us

Although I follow the major stock indexes, I prefer the visual inspection of the NYAD. That’s because in the NYAD one stock counts the same as another regardless of how large or small the stock is. Thus, the NYAD can’t be distorted by the capitalization weighing of large-cap stocks such as Microsoft (NSDQ: MSFT) and Netflix (NSDQ: NFLX).

When NYAD is rising, the stock market is in a healthy position because more stocks are rising than falling. That means that the odds of picking a winner are much higher than when NYAD is falling.

In a well-functioning market, the general trend of the major indexes and NYAD should be in synch. When they disagree, such as when one rises and the other falls or does not keep up, it’s considered a technical divergence.

A bullish divergence is when the NYAD is rising and the major indexes are rallying. These instances are often excellent buying opportunities.

A bearish divergence is what you see when the major indexes are rallying (behind mostly large-cap stocks) and NYAD is flat or declining. This is a sign that the majority of stocks in the market are starting to roll over. Negative divergences are often great places to take profits.

Where Things Stand

A review of NYAD shows the following:

• NYAD is above its 50- and 200-day moving averages; this is bullish;
• The Bollinger Bands are closing in on the price trend: this suggests a big move is approaching; and
• The RSI is currently near the 50 area. This is neutral, but leaning toward the bullish side.

Moreover, the VIX is trading near its recent lows, which signals volatility is low, while the XED is moving sideways signifying that liquidity, the fuel to buy stocks, is stable.

Bottom Line

The world seems to have escaped a close call. And no matter why, at the end of the day that’s a good thing.

From a market standpoint, the most reliable filter of the market’s trend, the NYAD and its associated indicators, suggest that the stock market is, for now, standing its ground, albeit trading in “complex” territory.

In addition, the shrinking of the Bollinger Bands is meaningful, because it’s a sign that volatility is decreasing and that a big move of some sort is on its way. It’s certainly difficult to predict which way the direction will be. But given the level of uncertainty and pessimism in the world and in the market, there is a large wall of worry in place.

The bigger the wall of worry, the more the potential for a bullish outcome.

Given the fact that we are entering the most bullish month of the year, July, and that the NYAD did not fall apart after the recent “weird” events in Russia, maybe that’s a bullish sign.

On the other hand, if NYAD breaks below the key support levels offered by the 20-, 50- and 200-day moving averages, the market would be trading in Chaos territory.

The bottom line is that investors should recognize that something meaningful is developing. Therefore, relying on time-tested indicators and preparing for as many potential outcomes as possible is the best approach.

That’s because, we’re dancing on the Edge of Chaos.

Editor’s Note: if you’re nervous about some of the risks highlighted in the above article, I suggest you consider the advice of our colleague, Jim Pearce.

Jim Pearce is chief investment strategist of our premium service Mayhem Trader. He has spent the past year perfecting a powerful indicator that’s designed to make money in a hostile market.

Jim has a proven knack for reaping profits from Wall Street chaos. To learn more, click here for his latest video presentation.

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