Detecting SP500 BUY-THE-DIP signals

In our prior research note “Detecting tops of rapid SP500 advances” we introduced a multi-factor model (BIGTOP, available now in the Dashboard) for signaling advance warning of major (infrequent) intra-bull SP500 stock market tops. Whilst not a precise actionable signaling tool, BIGTOP appears very good at warning you of when risks of major market tops are high, allowing you to mitigate downside risk.

If you recall, we opined that experience has shown us that detecting market tops is far harder than detecting market bottoms, due to the differing internals, dynamics and psychologies involved in market tops forming as opposed to market bottoms forming.

BIGTOP is a non-macroeconomic model, so its stands to reason that if we see high risks from BIGTOP accompanied by warnings from our various macroeconomic models, then we have a mechanism for bear market risk detection, where duration of the downtrend is likely to be much longer and size of drawdowns much higher. This is useful since risk mitigation for intra-bull tops is very different to that for bear market tops.

For the purposes of this research note we switch our attention to which of our models are most useful for detecting intra-bull stock market bottoms (or buy-the-dip signals). These are useful for traders, investors and funds alike. A trader could use them as entry signals for short term trades. An investor could use them to add to positions or re-enter the markets or scale back hedging. A fund could use them for pooling of inflows for tactical market deployment.

Since market bottoms are formed in much shorter time frames accompanied by fear and indiscriminate selling, we deploy a different set of tools for buy-the-dip strategies. Invariably these tools are far shorter-term in nature, and generate more signals than the tools we used for BIGTOP detection.

1. Zweig Breadth Thrust (ZBT)

This is our oldest and therefore our most widely used tool for buy-the-dip signals. It is discussed at length at  this widely read research note : “Zweig Breath Thrust Redux” and its decision logic and signaling chart is updated every 15 minutes in the CHARTS>ZWEIG tab. It is a very infrequent but high efficacy signal mechanism as shown below for the last 5 years:

2. Great Trough Detector (GTR)

This is our second oldest but also widely used tool for buy-the-dip signals. It is discussed in this research note and its signaling logic chart is also updated every 15 minutes in the CHARTS>GTR tab. It has many more signals than Zweig, but they are broken up into far less frequent (but more accurate) A signals and more common B signals:

Most subscribers consult these two models together since both provide signals where the other does not, and using them in tandem not only allows for double confirmation  but allows for more frequent actionable signals.

3. SIGS Model Diffusion

SIGS is a diffusion of 12 of our market timing models. It takes the count of models that are long and subtracts the count of models that are short to arrive at the net amount of long models. SIGS can therefore range from +12 (all models long) to -12 (all models short).

SIGS is available in Charts>Dashboard together with the individual status of each of the 12 models and its diffusion is shown below together with actionable buy-the-dip signals:

The logic for generating SIGS buy-the-dip signals works in two ways. The first, extreme events, works on the premise that things are extremely bearish when all models are short and SIGS is on -12. When things are at extremes like this we generate A-Signals in green whenever sigs rises from -12 to higher. The second, mild events, works on the premise that whenever sigs bounces up from touching either 0 or +2 (known bullish pivot points for SIGS), we generate B-Signals (purple)

4. Trendex Diffusion

Trendex are a set of highly popular (most viewed chart this year) short, medium and long-term support/resistance SP-500 stop technologies developed by RecessionALERT. When the SP500 is trading above a Trendex support stop, we remain long until the SP500 closes below the stop, at which point the stop switches to a resistance stop, and we stay short (or in cash) until the SP500 manages to close above the stop. The stops are available in the CHARTS>Trendex tab as depicted below.

The top pane shows the SP500 together with the three stops. The 2nd pane below it shows the Trendex Diffusion which is merely a count of how many support stops the SP500 is trading above. If its 3 then its maximum bullish and if its 0 its maximum bearish. The bottom two panes however are what generates interest in these charts as it depicts the market top probability and market bottom probability of each respective stop. These probabilities count how many sessions the SP500 is trading above/below the stop in question and compares this to the 20 year historical record to impute probabilities of things getting worse or better.

In general, whenever the Trendex Diffusion rises from 0 to higher, we generate a high confidence buy-the-dip signal, with the bottom pane depicting the probability of success (how extreme the event was). We want to see the Trendex Diffusion rising from 0 to 1 when as many probabilities in the bottom pane as possible are reaching for 85% or more.

Here are all the Trendex buy-the-dip signals generated from a diffusion rising from 0 to higher:

5.Conclusion

Whilst there are many other techniques using our models to detect market bottoms, we feel the four above represents the best of them. It is instructive to always consult the SP500 Market Bottom multifactor probability model when assessing your opportunity for these buy-on-the-dip signals. When you witness buy-on-the-dip signals accompanied by high probabilities of a market bottom and high probability diffusions (all available from the SP500 market bottom probability model) then you have a feeling for how rare and extreme the opportunity is, and hence the likelyhood of a successful outcome of a long position.

Whilst ZBT and GTR signals are currently posted to the REPORTS>Alerts tab, we will also be placing alerts for SIGS and Trendex.

About RecessionALERT

Dwaine has a Bachelor of Science honors degree and is a full-time trader and investor. His passion for numbers and keen research & analytic ability has helped grow RecessionALERT into a company used by hundreds of hedge funds, brokerage firms and financial advisers around the world.

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