Thinking behind market monitor

If you run in to a wall, don't give up. Figure out how to climb it, go through it or work around it,
Michael Jordan

One of the key to successful trading is understanding overall market direction and the impact it will have on your strategies. While there are many opinions on market direction, few have a rigorous methodology to anticipate possible correction zones or change in market direction. The Investors Business Daily uses number of distribution days to do it. Some use breadth numbers. Dan Zanger is a great fan of Mcclellan Oscillator to anticipate market turns.

Market monitor is my way of anticipating possible good and bad trading periods. The background to this market monitor thinking was based on volatility of my returns in early years. As you can see all the methods I use give stocks with high probability of going up. So many times I would build my account up by 30 or 40% or more in 3-4 months and then would be caught in one of the market corrections, ending up giving up 20 to 25% in few days.

So I developed market monitor method as an overall filter to avoid certain periods and reduce risk by getting out before a market correction. It has helped significantly. It is not perfect but it is conceptually a early warning signal system.

Momentum is cyclical. Momentum phases last for some period and then there is correction. Downside momentum reaches extreme and again there is reversal. Life would be very easy if we knew this cycle was say 3 months or four months. But in reality it does not work that precisely in timing terms. So one uses a proxy of breadth. Now the 65 days bull bear indicator is just a very crude breadth proxy. It tells us number of stocks making a certain 25% plus move in 65 days.

Momentum cycles will start with readings on bullish 65 days side being lower than bearish. At some stage the bullishness reaches extreme indicated by both 65 days number being high as in you will get 10:1 ratio or something. So in essence at momentum extreme few stocks are down 25% or more.

Now there is no exact number, but what I have seen and discovered through testing is when the number crosses below 200 or bearish or bullish side we have a probability of correction. So I start locking in profit, moving stops, reducing exposure, not taking fresh signals. Same way when bullish numbers reach below 200, most selling has happened, so I am very bullish, anticipating a turn. Rallies which start after number reaching below 200 are very ferocious and safe for putting large positions.

Now if we catch the turn zone then viola what happens is our positions start moving up, they reach extreme by the time the bearish number reach 200, so you have lots of profit. So why be greedy lock it in in anticipation of likely correction.

That in essence is how I use this thing.

The 50% plus in month supplements this indicator in the sense I have observed readings above 20 indicate red hot momentum and it is usually climax followed by correction.

Now these two things most of time move in tandem in the sense when bearish readings go below 200 on 65 the 50% plus readings are in 20 s. Now in current market I see an aberration where the 65 number has gone down on bearish side and approaching 200 almost but 50 number is stuck at 8-10 indicating churn.

Now none of this is perfect or scientific. It helps identify risky periods. It helps identify good periods for momentum strategies. Above all it helps make money..

So before blindly trading IBD200 or Double Trouble you must understand the market monitor. If you start trading a method at wrong time, you can very quickly get discouraged. Currently the market monitor is anticipating correction.

Later: Oh the thinks you can think...
Or why trading failure is failure of imagination...