This article is intended to be a quick update to this article. The original idea is based on the theory propounded by Ken Fischer that suggests that one should not worry about a “top” in the stock market until after the market goes at least 3 months without making a new high.
Three things to note:
*Like all trend-following methods the one detailed in the linked article will experience an occasional whipsaw, i.e., a sell signal at one price followed some time later by a new buy signal with the market at a higher price.
*Like any good trend-following method the real purpose is to help you avoid some significant portion of any major longer-term bear market, i.e., 1973-74, 2000-2002, 2007-2009).
*The secondary purpose is to relieve an investor of that constant “Is this the top, wait, what about this this, this looks like the top, OK never mind, but this, this time it definitely has to be the top” syndrome.
The Rules
For a full explanation of the rules please read the linked article. In general, though:
*A “Sell alert” occurs when the market makes a 6-month high, then goes 3 full calendar months without piercing that high
*The “trigger” price is the lowest low for the 3 months following the previous high
*A “Sell signal” occurs at the end of the month IF the “trigger” price is pierced to the downside during the current month
*The “trigger” is no longer valid if the S&P 500 makes a high above the high for the previous 6 months prior to an actual “Sell signal”
*If a “Sell signal” occurs then a new “Buy signal” occurs when the S&P 500 makes a high above the high for the previous 6 months
Sounds complicated, but its’s not. Figure 1 displays the signals and alerts and trigger prices since 2005.
Green Arrows = Buy Signal
Red Arrows = Sell Signal
Red horizontal lines = Sell trigger price
Figure 1 – One Minute a Month Trend-Following Alerts, Trigger prices and Signals (Courtesy WinWayChartsTradingExpert)
Note that actual sell signals occurred in 2008, 2011 and 2015. The signal in 2008 was a life-saver, while the signals in 2011 and 2015 resulted in small whipsaws. Sorry folks, that’s just the nature of the beast.
Interestingly, there have been two “Sell alerts” in the last year. The first occurred at the end of April 2018, however, that alert was invalidated at the end of August 2018 when the S&P 500 pierced the previous 6-month high. Another alert occurred at the end of December 2018. The “Trigger price” is the December 2018 low of 2346.58. That trigger is still active but could be invalidated if the month of May 2019 makes a high above whatever the high for April 2019 turns out to be.
The key point here is that despite the volatility and painful sell-offs in October and December of 2018, the “system” has remained on a buy signal.
Where to from here? We’ll just have to wait and see.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
First the reality. Nobody knows what the market is going to do. Yes, I am aware that there are roughly a bazillion people out there “prognosticating” (myself included) about the stock market. And yes, if one makes enough “predictions”, the law of averages dictates that one will be correct a certain percentage of the time.
Still, the market does offer clues. Sometimes those clues turn out to be false leads. But sometimes they do offer important information. For example, Figure 1 displays four major market indexes. As you can see, in the Aug-Sep-Oct time frame all four of these averages “broke out” to new all-time highs (i.e., The Good News) and then broke back down below the previous resistance line drawn on each chart (i.e., The Bad News).
Figure 1 – Four major indexes breakout then fail (Courtesy TradingExpert)
False breakouts happen all the time. And the reality here is that sometimes they mean something and sometimes they don’t. But when all four major average do the same thing, a warning sign has been issued to those who are interested in seeing it. That’s why it can be useful to seek “confirmation”. For my purposes I look to what I refer to as my 4 “bellwethers”, which are:
SMH – Semiconductors
TRAN – Dow Transportation Average
ZIV – Velocity Shares Inverse VIX Index
BID – Sotheby Holdings
These tickers appear in Figure 2 (click to enlarge).
While the major indexes were testing new highs in Aug/Sep and then breaking down in October:
SMH – Never really came close to breaking out above its March high
TRAN – Followed the major indexes by hitting new highs in Aug/SP and then breaking down in October
ZIV – Never came anywhere close to its Jan-2018 high
BID – Broke to a new high in Jun/Jul, then failed badly.
In a nutshell, the failed major index breakouts were accompanied by absolutely no positive signs from the 4 bellwethers. So, the warning signs were there if one wished to see them.
So where are the bellwethers now? Another close look at Figure 2 reveals that:
SMH – the key support level at 80.92
TRAN – the key level for the Dow Transports is 8744.36
ZIV – the key support level is 60.60
BID – a potential support level is 32.95 (the Apr 2013 low)
Summary
*Given the washed-out/oversold level that many indicators and sentiment surveys have reached…
*…Combined with the fact that we are in the seasonally favorable pre-election year (no down pre-election years since the 1930’s)
*There is a chance that 2019 could be surprisingly bullish, and shell-shocked investors should not stick their heads in the sand to the possibility.
At the same time:
*Based solely on trend-following indicators ALL of the major market indexes are technically in confirmed bear markets. As a result, there is absolutely nothing wrong with having some portion of one’s capital in defensive positions at the moment (30% cash or short-term bonds?).
*Keep a close eye on January performance. A bullish January would be a positive sign just as a negative January could – in this case – signal a continued market decline.
*Keep a close eye on the 4 Bellwethers relative to their respective support levels.
In a nutshell:
*Up January + Bellwethers holding above support = GOOD
*Down January + Bellwether breaking down below support = BAD
Those are all the “clues” I can offer at the moment.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
The AI in TradingExpert Pro is programmed with the knowledge and insight of many stock market professionals, and is capable of making market recommendations based on this knowledge and insight; recommendations are made on a scientific basis free of bias, emotion, or hidden motives.
The AI or expert systems are programmed with rules that combine sound principles of technical analysis with the knowledge and experience of market professionals. Technical analysis, as used by AIQ, is based on the logic that price is the result of supply and demand. An AIQ timing signal, therefore, reflects all available knowledge and opinions such as news of the day, earnings, product reports, and company forecasts.
Technical analysis recognizes price and volume movement as the voice of the market itself and hence the only data necessary to determine what the market is likely to do next.
The AIQ Expert System
As an expert system, TradingExpert Pro is comprised of two knowledge bases – one for market timing and a second for stock selection – and an inference engine. Knowledge, in the form of rules, is stored in the knowledge bases. The inference engine is the thinking component of an expert system.
Each of the two knowledge bases within TradingExpert Pro has its own unique rules. The rules operate on facts which are values of the technical indicators. The indicators are computed from daily price, volume, and breadth data.
The rules employed in ATQ TradingExpert Pro are derived from the knowledge of many experts of market action and market timing. The reliability of these rules is maximized by combining them into a higher level of Expert Rules. Market analysts have found that no single rule or indicator works all the time. In AIQ, the Expert Rules and technical indicators work together to generate upside and downside signals.
Different knowledge bases for different market cycles
Continuing research at AIQ has shown that a single knowledge base can be improved if it is split into several knowledge bases, one for each phase of the market cycle. This advancement has been incorporated in the market timing knowledge base. The crest, trough, up slope, and down slope are each addressed by a specific set of rules specialized and weighted for that specific phase of the market cycle.
Each market day, then, the system determines the strength and direction of the phase, or trend. If there is no trend, it is first determined if the cycle is at a crest prior to a downtrend, or in a trough before the next uptrend. A more specialized knowledge base is used for each of these conditions, increasing the overall market timing effectiveness.
The inference engine
The knowledge base fuels the second part of the AIQ expert system, the inference engine. The inference engine is the thinking component of an expert system, and mimics the way humans think.
To understand how the AIQ inference engine works, picture a decision tree. The procedure starts from the tree’s trunk, where the major rules are located. Each rule is represented as a node, or fork, where the tree splits into three branches-representing a yes, a no, or a maybe. If the expert system determines that the premise of a rule is true, then the rule is considered to have fired, giving one of those three answers.
As each rule is evaluated, the process moves on to the next node and subsequent branches and continues to move on through the tree. Each rule node has an assigned value. That value is added to a node total that is accumulated as the inference engine passes through the tree. When all the rules have been evaluated, the resulting node total is normalized and becomes an AIQ Expert Rating.
Finally
The Expert Ratings are based on a scale of 0 to l00. The higher the Expert Rating, the stronger the signal. An Expert Rating of 95 or higher is considered a strong signal, meaning that there is a strong possibility that the price trend is about to change direction.
Confirmation of Expert Ratings
Research has shown that a change in direction of the Phase indicator (changing up for up ER, changing down for down ER) at or close to the high Expert Rating date provides a higher degree of confidence in the rating. Phase is not part of the Expert System.
So let us examine the last 7 weeks market action.
2-98 down signal 9/18/2018, 9/18/18 and 9/20/18 all with these primary riles firing confirmed by phase
Intraday high prices of the market have increased to a 21 day high. Never the less, the advance/decline oscillator is negative. This unusual event is read as a very strong bearish signal that is often followed by an downward price movement.
Closing prices on the market have increased to a 21 day high but market breadth as measured by advances and declines is declining. This non-confirmation in a trading market is a weak bearish signal indicating a possible downward price movement.
DJIA with the 3 successive down signals
Confirmed down signal 4-96 on 10/05/18 these primary rules fires
Trend Status has changed to a strong down trend. This indicates that a downward trend has started that may continue in this direction. This is a moderate bearish signal.
The 21 day stochastic has declined below the 80% line and the price phase indicator is decreasing. In this strongly downtrending market this is an indication that the downtrend will continue.
Confirmed down signal 5-95 on 10/18/2018 these primary rules fires
The market closing average has dropped below the 21 day exponentially smoothed average price. At the same time, accumulation is decreasing. In this down trending market, this is taken as a very bearish signal that could be followed by further decreases in price.
The price phase indicator is positive but volume distribution has started to advance. This is a nonconformation that, regardless of the type of market, is a bearish signal which usually results in an downward movement of the market.
DJIA with 2 more down signals confirmed by phase
Unconfirmed up signal on 10/16/18 – phase did not change direction
Volume accumulation percentage is increasing and the 21 day stochastic has moved above the 20% line. In this downtrending market, this is taken as a strong bullish signal that could be followed by an upward price movement.
The price phase indicator is negative but volume accumulation has started to advance. This is a non-conformation that, regardless of the type of market, is a bullish signal which usually results in an upward movement of the market.
The new high/new low indicator has reversed to the upside. This is a reliable bullish signal that is often followed by an upward movement in prices. In this weak downtrending market an uptrend could start shortly.
DJIA on 10/16/18 97-3 up no phase confirmation
Confirmed up signal 10/31/18 98-2
The 21 day stochastic has advanced and crossed the 20% line and the price phase indicator is also in- creasing. In this weakly downtrending market this is taken as a strong bullish signal suggesting an increase in prices.
Volume accumulation percentage is increasing and the 21 day stochastic has moved above the 20% line. In this downtrending market, this is taken as a strong bullish signal that could be followed by an upward price movement.
The new high/new low indicator has reversed to the upside. This is a reliable bullish signal that is often followed by an upward movement in prices. In this weak downtrending market an uptrend could start shortly.
DJIA on 10/31/18 with confirmed up signal 98-2
While never perfect, the Expert rating provides a formidable advantage to the trader looking for signs of direction changes in the market. As of 11/7/18 close the DJIA was at 26180
So, the big question on every investor’s mind is “What Comes Next?” Since this is not an advisory service (and given the fact that I am not too good at predicting the future anyway) I have avoided commenting on “the state of the markets” lately. That being said, I do have a few “thoughts”:
*The major averages (as of this exact moment) are still mostly above their longer-term moving averages (200-day, 10-month, 40-week, and so on and so forth). So, on a trend-following basis the trend is still “up”.
*We are in the most favorable 15 months of the 48-month election cycle (though off to a pretty awful start obviously) which beings Oct.1 of the mid-term year and ends Dec. 31st of the pre-election year.
*Investors should be prepared for some volatility as bottoms following sharp drops usually take at least a little while to form and typically are choppy affairs. One day the market is up big and everyone breathes a sigh of relief and then the next day the market tanks. And so on and so forth.
An Indicator to Watch
At the outset let me state that there are no “magical” indicators. Still, there are some that typically are pretty useful. One that I follow I refer to as Nasdaq HiLoMA. It works as follows:
A = Nasdaq daily new highs
B = Nasdaq daily new lows
C = (A / (A+B)) * 100
D = 10-day moving average of C
C can range from 0% to 100%. D is simply a 10-day average of C.
Nasdaq HiLoMA = D
Interpretation: When Nasdaq HiLoMA drops below 20 the market is “oversold”.
Note that the sentence above says “the market is oversold” and NOT “BUY NOW AGGRESSIVELY WITH EVERY PENNY YOU HAVE.” This is an important distinction because – like most indicators – while this one may often give useful signals, it will occasionally give a completely false signal (i.e., the market will continue to decline significantly).
A couple of “finer points”:
*Look for the indicator to bottom out before considering it to be “bullish”.
*A rise back above 20 is often a sign that the decline is over (but, importantly, not always). Sometimes there may be another retest of recent lows and sometimes a bear market just re-exerts itself)
*If the 200-day moving average for the Dow or S&P 500 is currently trending lower be careful about using these signals. Signals are typically more useful if the 200-day moving average for these indexes is rising or at least drifting sideways rather than clearly trending lower (ala 2008).
Figures 2 through 8 displays the S&P 500 Index with the Nasdaq HiLoMA indicator. Click to enlarge any chart.
The stock market is in a favorable seasonal period and is oversold. As long as the former remains true, react accordingly (with proper risk controls in place of course).
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
Working on some slides for a seminar last week, it was apparent that breadth indicators on the NASDAQ signaled a divergence from the price action of the market.
Looking specifically at AD Ind and HI/LO, although other breadth measures told the same tale.
The AD indicator explained
The Advance/Decline Indicator is an exponentially weighted average of the net advancing versus declining issues. With this indicator, the direction of the trend is of importance and not the actual value of the indicator. When the indicator is increasing, advances are outweighing declines, and when it is decreasing, there are more declining issues than advancing.
The Advance/Decline Indicator is a breadth indicator very similar to the Advance/Decline Line. However, this indicator tends to be more sensitive and at times will signal a move earlier than the Advance/Decline Line.
The breadth was telling us something was amiss from last week. Take a look at this chart of the NASDAQ clearly a divergence was in place before the downturn.
Today’s (10-10-18) 316 point drop in the NASDAQ a 4% drop and nearly 9% drop from the high is close to the 10% corrective point and some buyers may come in over the next few days and keep the decline in check or not.
The markets are down between 6 and 10% in 5 days. Keeping good stops is a must in your portfolio to protect you from the worst of this. Using trailing stops between 7 and 10 % on stocks that are moving and protective stops 5 to 7 % below initial investment for example can easily reduce your losses in these volatile markets.
One of the benefits of being an avowed trend-follower is that it can allow you to avoid a lot of the “angst” that many investors suffer with each new twist and turn in the economic/financial/political/price of tea in China arena. Let’s face it, if you scan the internet, watch cable news or read the financial press you will always have at least – roughly – 10,000 “things” that you could be worried about that will kick the legs out from whatever bullish thing might be happening at the moment.
I have a friend (no, seriously) and his comment recently was “The next person that mentions the Hindenburg Omen gets punched in the face”. The bottom line: someone is always crying “Wolf”, and living in perpetual fear is – let’s be honest – kind of a crappy way to go through life. Which is why I typically advocate focusing on the major trends and not sweating all the small stuff along the way.
Yes, things can go wrong and yes it would be nice to have at least some sort of a heads up in advance. So, in an effort to not be completely ignorant of the goings on around me I do have a few “things” I follow in hopes of getting some “early warning” if trouble is brewing. I call them my 4 bellwethers.
The main thing I look for is “divergence” between the action for the major stock market indexes and the action of these bellwethers. Even the existence of divergences does NOT guarantee trouble. But more often than not, major market tops are presaged by some “signs of trouble”. So, let’s take a look.
The Major Indexes
Figure 1 displays the Dow, Nasdaq 100, S&P 500 and Russell 2000 indexes. As you can see, they are all in up trends, well above their respective 200-day moving averages and 3 of the 4 are at or near all-time highs. In other words, from a solely trend-following perspective, “Thing are swell, things are great.”
(click to enlarge)
Figure 1 – Four major indexes all in bullish trends (Courtesy WinWayCharts TradingExpert)
The Bellwethers
Figure 2 displays my 4 bellwethers – they are:
Ticker SMH: an ETF that tracks the semiconductor sector. The world runs on technology and technology runs on semiconductors.
Dow Transportation Index: Whether the Transports confirm or diverge from the Dow Industrials has long been used as a gauge of market health by investors.
Ticker ZIV: An ETF that is designed to track the inverse of the VIX Index. Long story, but bottom line, it should go up when the market goes up and vice versa. Any deviation from that standard can be a warning sign.
Ticker BID: Sotheby’s Holdings which run high-end auctions. Bottom line, if rich people are comfortable buying expensive stuff that is a good sign for the economy (and should be reflected in a rising trend in BID) and if rich people are NOT comfortable buying expensive stuff, well, vice versa.
As you can see, the Bellwethers are mostly not confirming the major average at the moment. This is not a reason to panic or fell angst. It is simply something to keep an eye on. The longer these divergences continue the more troublesome, so let’s focus on a couple of key things to watch to decide if maybe you should go ahead and start feeling angst.
Dow Transports
As you can see in Figure 3, double-tops in the Dow Transports have in the past signaled trouble for the overall stock market.
Figure 3 – Dow Transport double tops often a sign of impending trouble (Courtesy WinWayCharts TradingExpert)
The Good News and Bad News for the Transport Index is reflected in the daily chart shown in Figure 4. The Good News is that the Transports recently made a new all-time high. The Bad News is that price has subsequently fallen back below the important support/resistance level marked in Figure 4.
Figure 5 – Breakdowns in BID often an early warning sign (Courtesy WinWayCharts TradingExpert)
As you can see in Figure 6, BID recently tanked 25% before rebounding slightly. Is this a “Look Out Below” warning sign for the stock market? Dunno, but gonna keep a close eye on BID to see if it rebounds…or falls further.
Figure 6 – Ticker BID – which way from here? (Courtesy WinWayCharts TradingExpert)
Summary
The major market averages are (mostly) rallying to new highs while Jay’s 4 Market Bellwethers are, well, it’s too soon to say exactly what they are. But for the moment at least they are mostly not confirming the new highs in the major averages. Please try to remain calm. The proper response is Not fell angst and doubt, but rather to simply keep an eye on how things progress from here. If the Bellwethers start to move higher then “the crisis will have passed.” If not, then it will be very important to keep an eye open for – and to take seriously – signs of weakness in the major averages.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
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