Inflection Point Modeling

One comment that I have recently read a lot is that "Market is very resilient," and a common question that any market savvy person should ask is "Are we approaching a trend reversal?" In any case, both statements are very thought provoking, and I have been thinking about these two notions i.e. market's resilience and trend reversal, for the last few weeks. 

While I was thinking about these statements, I got myself involved in a neat little programming project. During this project I came across a unique method of analyzing the stock market's internal harmonics. This method might be useful in analyzing crucial trend reversals in conjunction with my favorite Market Matrix (which I will discuss over the weekend).

I have analyzed this model over various time-frames and have found it to be a good indicative tool. However, there is always room for improvement and I will try to do so on a regular basis. In any case, since modeling can never substitute real time analysis, observations and implementation, I am publishing the latest chart of this model. It shows SP500 along with various trend reversal signals generated by this model during the last 2 years.

Trend Analysis Model

Each of the two graph employs a different model for calculation and graphical purposes. It is evident from the plot that these models have generated several reversal signals, and almost all of them have corresponded to a short-term top or bottom. Thus, a natural question to ask would be that when is the next reversal date?

The next reversal date (according to the model) is highlighted in the plot. It comes out to be January 6, 2010 (+ or - 3 days). Now the question is, whether it will be a top or a bottom. The answer will depend on whether we drop into this reversal time window and then bottom out, or do we continue to rise into this reversal time window and then top out.

In short, right now these plots are suggesting that a significant trend reversal could occur within one week. This reversal can be significant because the reversal potential is present in both of these models. When viewing this trend-reversal date in conjunction with the current lopsided sentiment picture (extreme optimism) and completed wave structure, there is a very high possibility that we are approaching a high rather than a low and that this high can produce a significant decline.

Note: 

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: 

“The market can remain irrational longer than you can remain solvent.” - John Maynard Keynes

Break till December 18, 2010!!!

In financial markets there are times when one needs to be aggressive and other times, when one should allow the market to show its path. We are currently at one of these junctures, where my Market Analysis Matrix is painted like a rainbow. Therefore, I have decided to take this opportunity to observe the first 10 days of Muharram and to study for exams.

With contrasting signals abound, this is a very interesting time for the stock market. Market trend at all time frames is up, but the sentiment is pretty bullish indicating a decline. This confusion is amplified by unclear pattern of the recent, not so strong, rally, coupled with near-term cycles turn dates. Therefore, one should allow the market either to pull back or to start a strong rally, before jumping in.

Regular blog updates will continue after December 18, 2010.

In the mean time, if I do get some time and see some interesting development, I will write a quick post.

Note: Always trade alongside the major trend of the market. Mean reversion is a common aspect of different markets and also life i.e. anything which goes up must come down. But coming down does not mean a new bear market nor does it mean a personal life crisis. It is just a pause before we climb the next few stairs in our quest to destination.

In this regard, the most important question is, "How to differentiate between a 'Mean Reversion' and a new 'Bear Market'"?

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Stock Market, Trend Alignment and Indicators

As I was going to write about today's market action, I came across an unfinished post from Sunday - November 28, 2010. It seems like now is the best time for this post.

It was initially being written in response to an article published by Zero Hedge titled, "Smart Money Preparing For Sell Off Like Never Before." Please visit the following link for the original article at Zero Hedge.

The above mentioned article provided an interesting analysis of the recent anomalous stock market activity of the 'Company Insiders' and of the 'Smart Money People.' However, this behavior in itself did not guarantee a crash nor precluded a significant rise. This statement has been proven right by the strong rally of the last two days. On Sunday, in response to Zero Hedge's article, I wanted to stress the fact that these observations were just data points and not guarantees.

Financial markets are inherently intelligent and continuously evolving entities, and therefore, they should be followed rather than dictated. In order to trade successfully, one should align himself with the major market trend. In this regard, one should treat various key indicator based developments only as indicators rather than future predictors. However, if a development is extremely significant then one should trade with strong risk-management discipline.

One of the primary goals of "Understand, Survive and Thrive," was to present a broader overview of the stock market internals and to analyze these markets via the Market Analysis Matrix (used for weekly stock market review). This matrix is based on the below mentioned trading lessons, optimized for their respective significance.

Trading Matrix

This matrix shows the relative importance of each individual trading/investing component. If one follows these segments in a systematic manner, hopefully he will not only be aligned with the major trend but will also be successful in the financial markets.

I will continue to use my trading algorithm to continuously optimize this matrix and the corresponding Market Analysis Matrix. I will continue to update this blog with the latest state of this Matrix. In one of the future posts, I will further elaborate on this chart.