A Look Back at My May 20th Bottom Call

On May 20th, I published the following piece: Bottom Signal: Percentage of Stocks Above 20 and 50 Day Averages At Historic Lows. As the stats suggested it would be, the May 18th SPY close of $129.74 was within a percentage point from the actual bottom of $128.10, which occurred 10 days later on June 4th. The spread between the bottom call and the actual bottom was even closer on QQQ. I finished that post with this thought: “It is possible that we have not yet had enough capitulation for a bottom, but this study shows that we are likely very near to one.”

I find it helpful to continually review these indicators. In doing so, I’m wondering if the most important data point is the percentage of stocks above their 20 day averages. Thus, we would ignore the percentage of stocks above the 50 and 200 day averages.

Let’s look at the graph with the indicators in the bottom pane.

As we would expect, the PctAboveMA20, the green line, moves the fastest. It is probably the best indicator of this group to use for calling short-term swings. However, I was curious at how well it called bottoms when looking out at an intermediate term of 50 days.

Below are the results of those tests.

When the PctAboveMA20 < 15, the average trade for both SPY and QQQ is near 2% by the 3rd day. Those are pretty decent results over the short-term. Looking out over the full 50 days, the PctAboveMA20 bottom call appears to work well with an intermediate time frame. An average trade of 5-6% using QQQ is not too shabby.

It seems that we may be able to ignore the percentage of stocks above their 50 and 200 day averages, but before I write them off completely I want to run more tests. More on this in the future.

Modeling the Bottom: It Bounces and Then Flattens

Apologies for the double entendres. I still have bclund’s recent post on the brain. More seriously, on Monday, June 4th, SPY made a new 102 day low. As you are all well-aware, after making the new low, the market bounced, gaining slightly more than 3% as of today’s close. Tonight’s installment creates a rough model of this pattern, finds previous occurrences of it, and calculates historical performance after it occurs.

The Rules:

Buy SPY at the Close if

  1. it makes a new 100 day low AND
  2. the three-day rate-of-change is greater than 2.99%

SPY will be sold X days later.

No commissions or slippage included. All SPY history used.

The Results:

And below are the trades that were held the full 50 days:

While there were 21 occurrences of this setup, there were only 13 samples held for the full 50 days. Those trades are shown above.

Even though the modeling was a rough approximation and not extremely specific, it still did not yield very many samples. The typical caveats about small sample sizes apply.

I posted the individual trades because I thought it was important to understand the impact of the 2008 trades. If 2008 can be considered an outlier, than the rest of the results are promising.

I’ve heard many traders guessing that the next few days will bring some consolidation and then another pop. Modeling of recent action shows that historically, that has been true.

Modeling the Devils Bottom: Will We Revisit the Crack?

The market put in an incredible reversal today with a huge intraday swing which was even larger than yesterday’s -6.66% loss. Not surprisingly, the extreme down and back up volatility has not happened very often in the past. However, there have been similar instances, and they have all led to a re-test of the bottom.

Unfortunately, I tried exactly modeling the past two day’s market action, and there are only several comparable instances. I had to loosen the criteria a bit, and even then, I have only come up with 5 other occurrences. Describing recent market action as unprecedented would not be inappropriate.

Anyway, here is what I used to model the Devil’s Bottom.

Buy Rules:

  • Buy SPY if Yesterday Closed Down More than -2% and the Close was a 100 Day Low AND Today Closed Up More than 2% and Today’s Volume was More than Yesterday’s Volume
  • Sell X Days Later
  • No Commissions or Slippage Included
  • All SPY History Used

A quick word about my methodology: Yesterday’s volume was incredible, but if I get too specific trying to get a near match of yesterday’s volume, it limits the sample size. Therefore, I just required today’s volume to be more than yesterday’s. It seems to work as anytime the market is putting in new 100 day lows, volume is swelling.

I also tried requiring a new 200 day low (yesterday was a new 200 day low) but that limited sample size. Again, I sufficed for the less restrictive 100 day low.

I also tried messing around with the relationships between yesterday’s and today’s opens and closes. Again, it was just too restrictive. As it stands, even with the less restrictive buy rules above, there were only 5 samples, not including today.

The Results:

Bottom Line:

Every instance saw a re-test of lows.

I’m not at all confident that these results are generalizable due to the small sample size.

What I do know is that the market is still in an abnormal state in a climate of high volatility with a 200 day moving average that is rolling over. An abnormal market will do abnormal things, and even if volatility starts to decline, it will decline with ever smaller spikes and waves.

My money is on a re-test. As I am writing this, I am working through some possibly more effective and generalizable ways of determining whether a re-test is likely. Stay tuned!

Dow Jones Charts: 1921-1945

Comparing the current top (below, circled in red) with the 1929 top (above) clearly shows just how bad things can actually get. If we are to experience a prolonged meltdown, it appears the indexes have the potential to fall a lot farther than anyone is even imagining.

Update: I added the Nasdaq Composite chart at the very top as requested in the comments section.

From the top in 1929 to the bottom, the Dow Jones lost almost 90%. Were something similar to happen today, we would be seeing the Dow Jones print 1620.

Seeing a 50% drop from the October 2007 top seems more likely. I would not be surprised to see the Dow Jones print somewhere as low as 7,000-8,000.

I included this weekly look at the Depression Top for some comparison to the current top. Again, current charts look like they still have a ways to go.

Breadth Indicator Still Not Bottoming

Last night, as I was in the middle of my analysis, I pulled up two charts: Number of SPX stocks trading above their 50 day averages, and number of SPX stocks trading above their 200 day averages. What I found was confusing and unsettling: Neither chart showed breadth to be even close to a bottom.

Keep in mind that Danny’s Legend of Vance Bagger indicator is derived in part from the number of stocks trading above or below their 50 day averages. It should make sense why Danny has almost been screaming that the bottom is not yet near.

It would have been very wise for me to delve into the unsettling feeling these charts gave me last night, as I would have likely postponed my “This Is A Tradeable Bottom” post ’til a later date. Alas, humility is good for the soul, but not as good for the account balance.

The chart above shows that 78 stocks on the S&P500 dropped from above their 50 day average to beneath the average. Should a similar number of stocks move below the 50 day tomorrow, this breadth indicator will register a level that existed during the August 07, January 08, and July 08 bounces. This is circled on the chart.

This chart is the number of stocks on the S&P500 trading above their 200 day moving averages. Last night it closed with near 150 stocks still trading above the 200 day, which was good enough for August 07, but not good enough for September 08. Today, the S&P500 had 54 stocks kicked beneath the bear market average. While this Summer found this breadth indicator reversing at today’s level, It appears to me that another 60 stocks need to get knocked down for this indicator to be near the January and March bounce levels, which are circled.

I do not currently have data for previous bear markets, for these two measures of breadth. They may have ventured lower than where they bounced in January, during previous bear markets.

Here Comes the Double Bottom Double Talk

There will soon be talk across the internets about a double bottom. Here is a primer on the elusive chart pattern.

SPY 2002

As the Nasdaq has undercut previous lows, there is already talk of a double bottom. It is best to consult William O’Neil’s teachings on this chart pattern. According to WON, a double bottom will start by the index or equity making a new low. The stock then rallys 10-20%. After this sharp rally, the stock reverses, and undercuts the previous low. WON is a tad vague on whether the stock has to undercut the previous low in order for the pattern to be valid. It is stated that the 2nd low must equal, or in most cases, undercut the previous low. As the stock moves back up, the move up must be accompanied with above average volume. The buy point is achieved when the stock moves past the middle point of the W.

The chart above shows a somewhat a-typical double-bottom. This particular chart shows the bottom of the 2000-2002 bear market. Notice that the buy point is never triggered. Sticking to the methodology would have kept traders out of the index for months while it grinded lower.

SPY 1998

The chart above shows the SPY’s 1998 bottom. It is a textbook double bottom formation. Notice how the index pauses at the middle point of the W (the buy point) and at moving average resistance. Once the index clears the buy point and moving average resistance, it is off to the races.

Note that in each chart above, the MACD fails to make a new low while the price does. I find positive divergences in the MACD can be one of the best clues that a bottom has been put in.

SPY

Above is our current SPY chart. Note that it is lacking in W formation characteristic of the double bottom. More importantly, it has yet to undercut the previous low. Regardless, we can still identify the theoretical buy point.

Important points to ponder:

  • Since the characteristic W formation has not occurred, how has that changed the psychology which has shaped the pattern? I think the pattern is likely busted as longs and shorts alike have had ample time to consider the situation and position accordingly.
  • The SPY did not quite rally 10% from the first low.
  • Bulls will be screaming, “Buy, Buy!” as soon as a new low is made. However, that is not where the double bottom should be bought.
  • Should the SPY and DJI undercut previous lows and then rocket back up, price will soon overtake the 50 day average. My system has me enter when the price overtakes, then tests, and holds the 50 day average. As the double bottom buy point will be above the 50 day average, this confluence of signals would make me very bullish.
  • Can one index undercut previous lows and undergo a trend change without all the indexes undercutting previous lows?

VIX

Finally, I refuse to believe that the worst credit crisis and mortgage meltdown of the last half-century will end with the VIX at the level of 27.5

However, the indexes are nearing oversold, and are likely to bounce soon, but the best scenario for the pig-headed steers is to let everything fall apart before getting into the buying mode. My suspicion is that all the indexes need to undercut the previous lows. Then the bears may start getting nervous and the bulls can start regaining some confidence.

A Look Back at My May 20th Bottom Call

On May 20th, I published the following piece: Bottom Signal: Percentage of Stocks Above 20 and 50 Day Averages At Historic Lows. As the stats suggested it would be, the May 18th SPY close of $129.74 was within a percentage point from the actual bottom of $128.10, which occurred 10 days later on June 4th. The spread between the bottom call and the actual bottom was even closer on QQQ. I finished that post with this thought: “It is possible that we have not yet had enough capitulation for a bottom, but this study shows that we are likely very near to one.”

I find it helpful to continually review these indicators. In doing so, I’m wondering if the most important data point is the percentage of stocks above their 20 day averages. Thus, we would ignore the percentage of stocks above the 50 and 200 day averages.

Let’s look at the graph with the indicators in the bottom pane.

As we would expect, the PctAboveMA20, the green line, moves the fastest. It is probably the best indicator of this group to use for calling short-term swings. However, I was curious at how well it called bottoms when looking out at an intermediate term of 50 days.

Below are the results of those tests.

When the PctAboveMA20 < 15, the average trade for both SPY and QQQ is near 2% by the 3rd day. Those are pretty decent results over the short-term. Looking out over the full 50 days, the PctAboveMA20 bottom call appears to work well with an intermediate time frame. An average trade of 5-6% using QQQ is not too shabby.

It seems that we may be able to ignore the percentage of stocks above their 50 and 200 day averages, but before I write them off completely I want to run more tests. More on this in the future.

Modeling the Bottom: It Bounces and Then Flattens

Apologies for the double entendres. I still have bclund’s recent post on the brain. More seriously, on Monday, June 4th, SPY made a new 102 day low. As you are all well-aware, after making the new low, the market bounced, gaining slightly more than 3% as of today’s close. Tonight’s installment creates a rough model of this pattern, finds previous occurrences of it, and calculates historical performance after it occurs.

The Rules:

Buy SPY at the Close if

  1. it makes a new 100 day low AND
  2. the three-day rate-of-change is greater than 2.99%

SPY will be sold X days later.

No commissions or slippage included. All SPY history used.

The Results:

And below are the trades that were held the full 50 days:

While there were 21 occurrences of this setup, there were only 13 samples held for the full 50 days. Those trades are shown above.

Even though the modeling was a rough approximation and not extremely specific, it still did not yield very many samples. The typical caveats about small sample sizes apply.

I posted the individual trades because I thought it was important to understand the impact of the 2008 trades. If 2008 can be considered an outlier, than the rest of the results are promising.

I’ve heard many traders guessing that the next few days will bring some consolidation and then another pop. Modeling of recent action shows that historically, that has been true.

Modeling the Devils Bottom: Will We Revisit the Crack?

The market put in an incredible reversal today with a huge intraday swing which was even larger than yesterday’s -6.66% loss. Not surprisingly, the extreme down and back up volatility has not happened very often in the past. However, there have been similar instances, and they have all led to a re-test of the bottom.

Unfortunately, I tried exactly modeling the past two day’s market action, and there are only several comparable instances. I had to loosen the criteria a bit, and even then, I have only come up with 5 other occurrences. Describing recent market action as unprecedented would not be inappropriate.

Anyway, here is what I used to model the Devil’s Bottom.

Buy Rules:

  • Buy SPY if Yesterday Closed Down More than -2% and the Close was a 100 Day Low AND Today Closed Up More than 2% and Today’s Volume was More than Yesterday’s Volume
  • Sell X Days Later
  • No Commissions or Slippage Included
  • All SPY History Used

A quick word about my methodology: Yesterday’s volume was incredible, but if I get too specific trying to get a near match of yesterday’s volume, it limits the sample size. Therefore, I just required today’s volume to be more than yesterday’s. It seems to work as anytime the market is putting in new 100 day lows, volume is swelling.

I also tried requiring a new 200 day low (yesterday was a new 200 day low) but that limited sample size. Again, I sufficed for the less restrictive 100 day low.

I also tried messing around with the relationships between yesterday’s and today’s opens and closes. Again, it was just too restrictive. As it stands, even with the less restrictive buy rules above, there were only 5 samples, not including today.

The Results:

Bottom Line:

Every instance saw a re-test of lows.

I’m not at all confident that these results are generalizable due to the small sample size.

What I do know is that the market is still in an abnormal state in a climate of high volatility with a 200 day moving average that is rolling over. An abnormal market will do abnormal things, and even if volatility starts to decline, it will decline with ever smaller spikes and waves.

My money is on a re-test. As I am writing this, I am working through some possibly more effective and generalizable ways of determining whether a re-test is likely. Stay tuned!

Dow Jones Charts: 1921-1945

Comparing the current top (below, circled in red) with the 1929 top (above) clearly shows just how bad things can actually get. If we are to experience a prolonged meltdown, it appears the indexes have the potential to fall a lot farther than anyone is even imagining.

Update: I added the Nasdaq Composite chart at the very top as requested in the comments section.

From the top in 1929 to the bottom, the Dow Jones lost almost 90%. Were something similar to happen today, we would be seeing the Dow Jones print 1620.

Seeing a 50% drop from the October 2007 top seems more likely. I would not be surprised to see the Dow Jones print somewhere as low as 7,000-8,000.

I included this weekly look at the Depression Top for some comparison to the current top. Again, current charts look like they still have a ways to go.

Breadth Indicator Still Not Bottoming

Last night, as I was in the middle of my analysis, I pulled up two charts: Number of SPX stocks trading above their 50 day averages, and number of SPX stocks trading above their 200 day averages. What I found was confusing and unsettling: Neither chart showed breadth to be even close to a bottom.

Keep in mind that Danny’s Legend of Vance Bagger indicator is derived in part from the number of stocks trading above or below their 50 day averages. It should make sense why Danny has almost been screaming that the bottom is not yet near.

It would have been very wise for me to delve into the unsettling feeling these charts gave me last night, as I would have likely postponed my “This Is A Tradeable Bottom” post ’til a later date. Alas, humility is good for the soul, but not as good for the account balance.

The chart above shows that 78 stocks on the S&P500 dropped from above their 50 day average to beneath the average. Should a similar number of stocks move below the 50 day tomorrow, this breadth indicator will register a level that existed during the August 07, January 08, and July 08 bounces. This is circled on the chart.

This chart is the number of stocks on the S&P500 trading above their 200 day moving averages. Last night it closed with near 150 stocks still trading above the 200 day, which was good enough for August 07, but not good enough for September 08. Today, the S&P500 had 54 stocks kicked beneath the bear market average. While this Summer found this breadth indicator reversing at today’s level, It appears to me that another 60 stocks need to get knocked down for this indicator to be near the January and March bounce levels, which are circled.

I do not currently have data for previous bear markets, for these two measures of breadth. They may have ventured lower than where they bounced in January, during previous bear markets.

Here Comes the Double Bottom Double Talk

There will soon be talk across the internets about a double bottom. Here is a primer on the elusive chart pattern.

SPY 2002

As the Nasdaq has undercut previous lows, there is already talk of a double bottom. It is best to consult William O’Neil’s teachings on this chart pattern. According to WON, a double bottom will start by the index or equity making a new low. The stock then rallys 10-20%. After this sharp rally, the stock reverses, and undercuts the previous low. WON is a tad vague on whether the stock has to undercut the previous low in order for the pattern to be valid. It is stated that the 2nd low must equal, or in most cases, undercut the previous low. As the stock moves back up, the move up must be accompanied with above average volume. The buy point is achieved when the stock moves past the middle point of the W.

The chart above shows a somewhat a-typical double-bottom. This particular chart shows the bottom of the 2000-2002 bear market. Notice that the buy point is never triggered. Sticking to the methodology would have kept traders out of the index for months while it grinded lower.

SPY 1998

The chart above shows the SPY’s 1998 bottom. It is a textbook double bottom formation. Notice how the index pauses at the middle point of the W (the buy point) and at moving average resistance. Once the index clears the buy point and moving average resistance, it is off to the races.

Note that in each chart above, the MACD fails to make a new low while the price does. I find positive divergences in the MACD can be one of the best clues that a bottom has been put in.

SPY

Above is our current SPY chart. Note that it is lacking in W formation characteristic of the double bottom. More importantly, it has yet to undercut the previous low. Regardless, we can still identify the theoretical buy point.

Important points to ponder:

  • Since the characteristic W formation has not occurred, how has that changed the psychology which has shaped the pattern? I think the pattern is likely busted as longs and shorts alike have had ample time to consider the situation and position accordingly.
  • The SPY did not quite rally 10% from the first low.
  • Bulls will be screaming, “Buy, Buy!” as soon as a new low is made. However, that is not where the double bottom should be bought.
  • Should the SPY and DJI undercut previous lows and then rocket back up, price will soon overtake the 50 day average. My system has me enter when the price overtakes, then tests, and holds the 50 day average. As the double bottom buy point will be above the 50 day average, this confluence of signals would make me very bullish.
  • Can one index undercut previous lows and undergo a trend change without all the indexes undercutting previous lows?

VIX

Finally, I refuse to believe that the worst credit crisis and mortgage meltdown of the last half-century will end with the VIX at the level of 27.5

However, the indexes are nearing oversold, and are likely to bounce soon, but the best scenario for the pig-headed steers is to let everything fall apart before getting into the buying mode. My suspicion is that all the indexes need to undercut the previous lows. Then the bears may start getting nervous and the bulls can start regaining some confidence.

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