Wednesday, January 12, 2011

Inflection Point Modeling - Meaning, Strategy & Application

Last year, I stated that the inflection point models were suggesting a top around January 6, 2011 in the financial markets. Interestingly, SP500 registered its highest price for 2011 on January 6, 2011. It has been going sideways since then. 

In order to refine the model based on the most recent market data, I re-ran the two inflection point models. To my amazement, I came across two very interesting observations:

1- In the re-run, model 1 is still suggesting that a turn took place on January 6, 2011. However, model 2 is not showing any indication of a turn taking place around January 6, 2011. This inconsistent behavior can be a sign that the recent top was not a significant top i.e. we might not witness a serious decline. 

2- According to the re-run, next turn-date is predicted in mid February 2011. Interestingly, both models are in agreement regarding the next turn date. This date is also confirmed by several other market measures. Therefore, in February 2011 we might witness a more significant top than the top of January 2011. 
Although currently there are several reasons to be bearish on this market, one should not trade against the trend. And according to all of my trend indicators, we are still in an uptrend. One question that I have been asking myself, is that how to use this data for trading purposes. In this regard, there are typically three scenarios in which this turn date can play out:

1- Market tops and Declines till the next turn date - Highest Probability
This was the highest probability scenario because of optimistic extremes evident from different surveys, complete EW structure and faltering rally.

2- Market pauses (shallow decline/sideways), Resumes uptrend and Top at the next turn date - Medium Probability 
Although this was initially a lower probability option, if the market does manage to rise above 1282 then it would suggest that market's resilience is appreciable. In that case market will most probably march higher into February 2011.

3- Market rises, and then Falls into the turn date - Lowest Probability
This situation is possible if market makes a top in late January 2011. The best technique to counter this scenario is to have a tight stop. Therefore, if the market falls below a particular level then one should exit. In this way, he will be sure of the new direction. As of today, this level on a closing basis is 1265 for SP500.

Next time, I will try to further explore these turn dates in conjunction with the Market Matrix.

1- If the market did not decline or rise at one of these trend reversal points, then it went sideways for some time. It normally happened in strong up or down trends.
2- Always trade in the direction of the trend. Even if there is a trend reversal date, wait for confirmation by other signals because: 

No comments:

Post a Comment

I would love to hear from you! Please leave your comment below!!