Regular readers of this blog will be familiar with my “Bear-o-meter” risk/reward compilation. Briefly, the Bear-o-meter is a compilation of some trend, breadth, sentiment and momentum indicators. They examine the S&P 500 from a longer termed risk/reward perspective. While the compilation’s readings can often signal market changes, it’s not really meant to be so much of a timing tool. It is more to understand the relative risk vs. relative reward we assume when investing at a given time.
Just because the compilation suggests high risk, doesn’t mean the market is about to crash. For example, the Bear-o-meter read a very high risk condition in May 2017.
The market continued on a rampage and went parabolic in the second half of 2017. Eventually, the risk was realized. In January of this year we got a 10% correction, but it took a while for that to materialize. Nine months later, the S&P 500 is still struggling to break its January high of just over 2900. By moving sideways, the market is now paying the price for the risk it failed to materialize in 2017. This has happened before. Here is a chart of the S&P 500 that illustrates how low volatility or parabolic moves are basically always followed by a sideways choppy period (as this year), or a market crash. Black arrows indicate low volatility/or parabolic market conditions. Excess corrects itself.
The Bear-o-meter remained neutral for most of this summer.
Interestingly, it recently moved to the top end of neutral. As you can see on the diagram below, the level of “5” indicates a reading that is just below the “lower risk” zone. Interesting, indeed, when we consider the time of the year. September is, statistically speaking, the most probable month for a market correction. So “whaz-up” with that???
Well, recall that the Bear-o-meter is a probability study—not a timing tool. All we know from its current reading is that – despite the probable or possible likelihood of a correction in the coming weeks, it is not likely to be a dire one. Backed by this is the Short Termed timing model, seen below. It signalled the overbought conditions earlier this month, and the market politely followed through with a small correction. But right now, the signal is not there. Thus, I am inclined to believe that markets may remain sideways, or drift down in the coming weeks. I don’t see a significant markdown just yet – possibly just weakness or sideways action. But that can change. I’ll report any change in probabilities on this blog as/if/when they happen.
Because the Bear-o-meter is so ‘forward looking”, I have also been using a short termed timing system using daily charts to try to be a bit more precise on the timing of a potential crash. Here is a blog to help you understand how the Bear-o-meter and the Short termed timing system can work together. the short termed timing chart is below.
It has its own challenges in parabolic market conditions such as late 2017. My short termed system relies on overbought or oversold momentum indicators (RSI, stochastics), along with standard deviation (via Bollinger Bands) to spot conditions that are ripe for reversal. When markets go nuts, as they did late last year, things remain overbought for a long time –sending these momentum and statistical bands into their respective overbought levels for extended periods. Note all of the vertical red bars, indicating “sell”, during late 2017. But, I want to note that conditions like last year are pretty rare. In other words –most of the time we can catch a trade with short termed timing tools like I use on that study.
For now, I remain neutral. I hold about 20% cash in the ValueTrend Equity Platform. That’s enough to dampen volatility a bit, and provide capital to invest should the market live up to its statistical averages over the next few weeks.
I have a couple questions on your short term trading system. How do you determine when to exit your short term trades (both when the trade is moving unfavourably and when its moving favourably)? Also do you consider stochastics to be oversold/overbought based on %K or %D?
%K is so close to the 3-day SMA (%D) that i look for the move of %K below or above the trigger line–it typically coincides with %D on the daily chart like a a shadow anyhow–the %D is a trigger line for some traders. I use it (the short timing model) to refine entry or exits based on my bigger picture work–via trend analysis and Bear-o-meter signals. So if the big picture says things are breaking down on the weekly chart via my “lower peak, lower trough, break of the 200 day SMA – and particularly if the Bear-o-meter is bearish – I then use the short termed system to see if the market is momentarily oversold, and may bounce–and wait for it to give me a sell signal for best possible price –recall that if the trend analysis noted above shows a breakdown, things are already lower, so now I am just looking for a ‘best exit” price–and the short timing sysltem helps me define that price.
The following link is a page on our website that does a decent job of illustrating our big-picture trading style: https://www.valuetrend.ca/our-approach-portfolio-management-strategies/