Rally Central. Bottom Callers Out Again.

It seems every so often we go through these periods where everyone wants to proudly call a stock market bottom or anticipate one. But, real money is not made by frittering away capital on false signals or by being the first hero to buy into a decline. It shows a lack of risk management and leads to draw downs in capital. What one should really be looking for is a tradable trend. There are many ways to look for such an occurrence if one understands what characteristics an algorithm should capture.

Above is a trend-seeking algorithm that works with futures or cash vehicles that have deep liquidity. The algorithm is overlaid on the S&P but it could just as easily be oil, gold, oil ETFs or even Google or Apple. It works quite accurately in any time frame including on an intraday, daily and weekly basis. It's most effective for longer term trends using a weekly time frame. Might I add its weekly reading isn't pretty. What I look for from a daily perspective with this algorithm is nothing more than a high probability development of a tradable trend off of a correction of 7% or more. The only thing one should focus on in the graphic above are the readings immediately after a correction. Readings other than that are often erratic as buyers become less involved in a rally the further it progresses. That said, it clearly telegraphed the rally into June of 2007 was likely to lead to a failure.

I can adjust the sensitivity to provide faster response but find in this type of market the chop is too severe and one gets more false signals. The goal is to avoid false signals which result in draw downs. There are a handful of rules I use with this widget. These only apply after we have seen a correction and are looking for a new rally.

-When the red line rises above the green line, there are short term buyers in the market.
-When the red line rises above zero there are substantial short term buyers in the market.
-When the green line rises above zero a trend of many months or longer has potential.

Of course, I never use this in a vacuum nor do I use it to initiate any positions. It's just a 'nice to know'. We are looking at it now as being nice to know.

In the last ten years, the lowest reading on the algorithm is -500. This oversold reading does not imply a tradable bottom. It may simply mean the market may rally a few percentage points to work off an oversold condition before declining further. We are currently at -300 and falling. There is nothing to prevent a reading of well below -500. While the current level of oversold has led to the market stabilizing over the past few years as shown on the chart, often throughout history's brutal declines, we may see an oversold readings become more oversold and reprieves followed by even more selling. The only thing one can infer from today's readings are that there is no way one should be buying here. That is, unless you are a hero. Then I applaud your bravery because over time your wallet is going to shrink substantially. Did you see the movie Jaws? How many want to be the first one back in the water?

To say that the risks of this market are the highest of any in my adult life is a fact. We could see a bounce or we could easily drop another ten or twenty percent before a reprieve or we could crash. No one really knows how far a decline will go so it is best not to be a hero. I wrote that 1100-1150 on the S&P was a probable next stop but that's also a guess. Somewhat of an educated one but a guess nonetheless. What isn't a guess is that my widget tells me I should not be in this market.