Welcome to the new TradeStops Investor Update.

Over the past few months I’ve been providing occasional market observations in my weekly editorial. Starting this week I’ll be sharing a few of my market observations and proprietary indicators in a second weekly editorial – published on Fridays.

My focus will be on events that I expect to play out over the course of months or years as opposed to short-term trading opportunities.

So, without further ado …

Back in September I introduced the idea of threat levels in the financial markets. These threat levels are adapted from the situational awareness practices of the police and military. If you want to more detail on this idea, you can read that article here but the core idea is that there are four threat levels each requiring different levels of vigilance and awareness:

  • White: Relaxed. Not worrying about what’s going on around you.
  • Yellow: Relaxed but in a heightened state of awareness. You’re not going to be caught off guard but you’re not necessarily expecting anything bad to happen.
  • Orange: There is real cause for concern. Nothing disastrous has happened but you know it could happen any day now and you’re on constant alert.
  • Red: You’re in real danger. An attack is headed your way. You’re ready to defend yourself.

Since September, I’ve been saying that I believe we’re currently in condition Orange as far as the stock market is concerned. We’ve seen expanding volatility – the most serious corrections we’ve seen in 6 years – and we’ve seen deteriorating market internals.

After a strong October, I’m tempted to say now that we can downgrade the threat level to Yellow. However, I still see cause for concern.

In fact, the very fact that I’m tempted to let my guard down is a red flag for me.

You see, I used to think that I was “different” than other investors … that I was “smarter” and “more informed”. I don’t think that way anymore. Now I know that the investing world is filled with very smart people – many with much more extensive resources than I have at my disposal.

So now, rather than thinking that I’m ahead of everyone else, I take my “first response” emotions and beliefs as an indicator of what the rest of the market participants are probably thinking as well. Then I practice “second-level thinking”.

I ask myself, “If this is what most participants feeling and thinking then what’s actually likely to happen? If most folks are starting to get a sense of complacency, what’s the next logical move?”

My personal guess is that we’re headed for a near-term shakedown before finally breaking out to new highs through the spring of 2016.

Let me show why I favor this scenario.

Both the S&P 500 and the NASDAQ Composite indices have formed nearly identical chart patterns.

  • They were both stopped-out in August with the Smart Moving Average turning over.
  • They both rallied strongly in October right up to obvious resistance levels from which they turned back.
  • Their Smart Moving Averages are both levelling off and even turning up ever so slightly.
  • Neither has yet triggered a Re-Entry Rule.

SandP 500 index
 

Nasdaq Composite Index

Its border line times like these when I tend to rely more heavily on my time-cycles research.

There is a prominent long term cycle in the S&P 500 of 260 days. This cycle has recently bottomed and will peak again in March of 2016. Until then it will likely be a wind at the back of stocks through the spring of 2016.

SandP trading cycles

However, before that wind really picks up speed, it’s going to have to contend with the shorter term 57.5 day cycle that bottoms in early December of 2015.

SandP trading cycles2

This picture that the cycles are painting dove-tails nicely with my second-level thinking about the market. Granted, this is just my personal belief and I need to be careful about confirmation bias, but I do think that it’s a scenario worth considering.
I wouldn’t be surprised to see the stock market make new highs in the coming days – just enough to convince everyone that we’re off to the races – only to pull the rug out from under us with a sharp correction through the first half of December.

If it does, it should present some good new entry points for investors.

Good investing,

Richard_Signature
Richard M. Smith, PhD
CEO, TradeSmith
Founder, TradeStops.com