1 Month Low Signal

After reviewing past similar signals to today's bottom reversal signal in the S&P 500 there is not enough of a positive forward skew for me to suggest speculating on the long side at this point. 

During the 2009-2015 bull market these signals did produce a positive skew in forward return compared to random.  These are the stats for the current bull market.

The first 3 days after the signal showed only a tiny positive skew in max gain versus max loss.

The first 2 weeks after the signal showed a ~1.5:1 max gain to max loss.

At 1 and 2 months out from the signal, the max gain was 1.7 and 1.8 times the max loss, respectively.  Given that some signals that my system flags may show or 3 times greater max gains than losses in the trade direction, there are much better opportunities to wait for.

At this point, I think a probable scenario would be for a 1-3 day rebound followed by a move to new corrective lows.  Most signals that failed to produce substantial rallies had 3 day or less rallies before topping.

Such a rebound may back test the underside of the lower boundary of the rising wedge.

These are just ideas, without a clear cut trading indication here.


Pete

1 Month Low Signal In Stocks - Probably Just a Short Term Pause Before More Downside

Thursday's price action registered a "1 month low" signal in my bottom spotting algorithm.  These signals can be traded on the signal alone, but as an estimation, about 50% of failed signals will be removed if you wait for a close above the high of the signal day.  The downside of that method is that your reward to risk ratio will be smaller.

In any case, I track this signal primarily to be alerted to as many potential inflection points in the market as I can.  But I don't consider it to be a consistently outstanding signal for going long a market.  I like to have other factors also clearly pointing to an upside skew to trade on this signal.  I have other signals that I prefer to trade on for going long the US stock indexes.

Click on Chart to Enlarge - Bull Market Signals

This chart shows all the "1 month low" signals generated going back to the 2009 bear market low.  The averages at the bottom show the future 2 month max gains and losses in both the SPY etf as well as a proprietary at the money call and put option max gain calculation if buying exactly 2 months until expiration at each signal.  The results show a modest upside skew during the bull market.  So if the bull market remains intact, we may expect SPY to rise to roughly 213.00 during the next 2 months.  And an AVERAGE May expiration call option may be expected to gain 100% or so within the next 2 months.  In order to expect to capture nearly that on average on these signals, quality option exit points will need to be objectively flagged.  I also have an algorithm which nicely identifies such key points as a market rises.

Click on Chart to Enlarge - 2007-2009 Bear Market Signals

This chart shows all the "1 month low" signals which occurred during the last bear market.  The averages shows a distinctly negative skew here.  So the signal often flagged a very short term pause in the market decline, but not the type of signal you want to trade on in a downtrend.  It could be used to help you identify short term covering points on short positions or put options, but I would not use it as a buy signal in a downtrend.  So the point here is that if the bull market has topped, we realistically don't have any quality upside expectation, and price is not too far off the highs.  

Click on Chart to Enlarge - 2000-2002 Bear Market Signals

This chart shows the "1 month low" signals generated during the 2000-2002 bear market.  Again the averages show a negative skew to future price movement.  So nothing to add here.

If you are short stocks currently, I would view this signal as a partial exit position to help create an objective scale out process.  My suggestion would be to exit 1/3 to 1/2 of the short position, and hold the rest of the position short and await another signal to be generated at a lower low.  

OF NOTE here.....while a signal was generated on Thursday, a qualitative examination of the price reversal on Thursday reveals a very weak reversal bar.  The close was near the midpoint rather than the top of the range.  And the high-low range of the bar was modest, indicating the day was not likely a major flush out of positions on either side.  I feel that this signal is more likely a temporary blip in a market with at least a little more downside likely to unfold.  That is my opinion anyway from observing many signals and understanding how they are derived.

Click on Chart to Enlarge

To further quantify the signal, the right edge of the chart shows the current level of fear/panic in the market as evidenced by several real money measures of market sentiment.  The point here is that this week's decline did not cause much of a spike in the fear, and there is no statistical extreme even given the recent range trade in the market.  A signal without a corresponding extreme is much less significant in my opinion.

Hopefully this information is helpful in determining how to manage your trading positions.  In short my take given the data here and the price logic confirmation to the downside, I think prices will fall at least modestly lower before a better buying signal or short covering signal occurs.

Pete

Potential Bottom Reversal Today

Based off of today's price and sentiment action, my bottom picking system has noted this as a possible inflection point.  The current signal is only at a 2 month low, and I view it as somewhat less significant and reliable than signals that happen at 3 month lows or more.

When a signal like this occurs, I don't consider the signal to get confirmed unless the reversal day's high is exceeded.  So, a higher high tomorrow would be a potential buy signal.

The recent signals going back to the May 2011 high are listed in the picture below.  Not all signals were confirmed with a higher high, but if you want to look at a price chart to get a feel for where these signals show up, and what the reward to risk profiles have been, then these will give a decent start.

Most of those signals either market significant lows, or led to at least a short term (1 day or more) price rebound.  Again, these signals are not super high specificity, they are designed to be highly SENSITIVE, so that just about every significant market low in an uptrend will be flagged for a buy.

Click on Chart to Enlarge

This chart shows a graphical/quantitative picture of the indicator that is evaluated into the logical buy signals such as those above.  This gives a sense of the magnitude of panic in the market relative to past market action.  We see that currently the level is approximating the levels of market panic at most of the lows the last 2 years.  The June 2013 saw higher panic levels, and it also was of longer duration and greater magnitude than the other corrections shown on this chart.

So this is just an objective heads up that if stocks are to continue an uptrend, this would be a logical point for a potential reversal. If buying long, the stop would go below today's low.  An exit signal would be taken at an opposite statistical extreme, or a stop movement mechanism could be used if prices rally from here.

So don't necessarily take this as a trade.  But use it in your analysis for a potential long trade set-up.  And as always, the key is managing the trade in terms of stops and having a definitive/objective profit taking or securing method as the price action unfolds.

Pete