Things could get fun from here…

At last, a decent pullback with a fat red candle on the SP-500. If the premise (see “Seven Paw-prints of the Bear“) is that we are in a well established bull market (we don’t care if its liquidity or economically fueled) then this could become a desperately needed “buy on the dip” opportunity to get aboard the train if were not already on it, or place additional funds into the market.

Firstly, the big red candle on the SP-500 has not yet hit the ABORT stop for the second leg of the SP-500 Market Timing Strategy. With 50% profit locked in on the initial A-leg’s 6.3% gain this could very well play out like the last trade that had an A (5.9%) and B (-2.1%) leg. As the research note states, success rates on the B-legs are much lower than the A legs, but the ABORT stop on the B-legs keeps losses to a minimum – losses that are worthwhile entertaining since when the B-legs do run, they run big.

We had our first shot across the bows yesterday when the large-down-days component of the Selling Pressure Index rose from 0 to 1. This is just a (very good) preliminary correction warning, and we need another large down day before the Selling Pressure Diffusion rises from 0 to 1. When this occurs we have our final warning that a not-inconsequential  correction is play. I have several trading staff that trade the Selling Pressure Index successfully on the SP-500 by entering on the trough reversal BUY signals (when the Selling Pressure Diffusion drops below 4) and then selling one-third when the big-down days jumps from 0 to 1, selling another third when the Selling Pressure Diffusion rises from 0 to 1 and selling the final third when the Selling Pressure diffusion rises from 1 to 2:

A few clients emailed in after last nights close, querying whether the Great Trough Detector had closed below the SP-500 correction warning threshold. It was not apparent from the live chart if the yellow line had closed below the horizontal orange threshold. It is easy to figure this out – just inspect the green shaded Sling-shot Signal at the bottom of the chart. It will rise when the yellow breadth signal falls below the orange horizontal line and it will rise yet again when the yellow line falls below the red “Deep Trough” threshold. You can see the Sling-shot has risen to 1, implying we have the correction warning in place. This warning has an excellent track record, on par with that of the “Large down Days” indicator. It implies more volatility ahead, but it also implies that we have armed the trough detection algorithm since we now have 10 days for the yellow line to rise above the horizontal green buy trigger to issue a Class-B BUY signal for the SP-500. When this happens, the Slingshot signal on the bottom will rise above the horizontal dashed green line “BUY TRIGGER” to trigger the BUY signal.

Things are also hotting up for the RecessionALERT Zweig Breadth Thrust Redux algorithm. This has far more stringent requirements for issuing trough reversal BUY signals and breadth has been deteriorating for about two weeks now, sitting at 44.5. When it drops below 40 we will arm the system (like taking the safety catch off the gun but not pulling the trigger yet) by rising the green shaded histogram in the bottom panel. This will mean both the original ZBT and the reduxed ZBT-B will be primed (a fancy way for saying “we are now interested in the opportunity“)

We sincerely hope a meaningful correction of the order of 3-5% ensues. Not only will this prime all the trough reversal algorithms for high confidence “buy on the dip” signals but it will put in place a platform from which the SP-500 can launch to new highs. It will make the SP-500 a fun place to be again.

If you want to have some ideas about how to use all the various charts together in a trading and investing regime, have a look at the “Market Timing – putting it all together” note we published a while back.

About RecessionALERT

Dwaine has a Bachelor of Science (BSc Hons) university degree majoring in computer science, math & statistics 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.