April 20, 2014

Short-Term High-Probability, Mean Reversion Indicator- Major Benchmarks Hit Short-Term Extreme

First of all I would like to thank all of you for your patience over the past week. I decided to take a brief hiatus from my daily writing, but that does not mean that my trading ceased. I actually placed a trade in the High-Probability, Mean-Reversion strategy last week and hopefully I will have some positive news to report early next week. Anyway…..

All of the major indices have moved into a short-term “very overbought” state. More often than not, this type of reading signals a short-term reprieve in the market. There are still unclosed gaps from 2/1 and more recently 2/7. I would expect both gaps to close as we move towards the bearish portion of February – the second worst performing month for the market.

Another short-term bearish sign is Cisco’s horrible earnings report. The report led to a 15% decline in the stock this past week.

According to Jason Goepfert, “the last 3 Cisco earnings reports, each of which saw the stock get hit hard the next morning, also coincided pretty closely with the last three corrections in stocks in general (mid May, August and November).  Over the 10 days following those reports, the S&P 500, at its worst point, lost -11.1%, -4.6% and -3.7%”.

As for last week, well, it was another glorious week for the bulls. Basically, I could just copy and paste the previous statement since the rally began back in September.  The stock market has now advanced for five consecutive months, and the S&P 500  is up roughly 26% since September 1. The Dow moved to its highest level since June 2008. It has certainly been a remarkable run for the market.

Market optimism has also been increasing during this time. For 23 consecutive weeks, surveys by the American Association of Individual Investors (AAII) have shown a greater-than-average belief that stock prices will rise. The last time the surveys had such a long streak of bullish sentiment was in 2004 –  in the middle of a 4 ½ year rally.

I really do not care if the market continues to rally over the intermediate to long-term. However, I do care about the short-term. Given the extreme readings in the ETFs I follow (check below) I would expect to see a short-term decline as we enter the early part of next week. This would certainly lead to another profitable trade in the strategy.

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Short-Term High-Probability, Mean-Reversion Indicator – as of close 2/11/11

Benchmark ETFs

* S&P 500 (SPY) – 81.2 (very overbought)
* Dow Jones (DIA) 87.0 (very overbought )
*Russell 2000 (IWM) – 80.1 (very overbought)
* NASDAQ 100 (QQQQ) – 81.7 (very overbought)

Sector ETFs

*Biotech (IBB) – 51.2 (neutral)
* Consumer Discretionary (XLY) – 88.1 (very overbought)
* Health Care (XLV) – 65.1 (neutral)
* Financial (XLF) – 76.4 (overbought)
* Energy (XLE) – 60.6 (neutral)
* Gold Miners (GDX) – 46.5 (neutral)
* Industrial (XLI) – 88.8 (very overbought)
* Materials (XLB) – 68.4 (neutral)
*Real Estate (IYR) – 81.3 (very overbought)
* Retail (RTH) – 71.5 (overbought)
* Semiconductor (SMH) – 77.0 (overbought)
* United States Oil Fund (USO) – 23.1 (oversold)

* Utilities (XLU) – 53.6 (neutral)

International ETFs

* Brazil (EWZ) – 48.3 (neutral)
* China 25 (FXI) – 33.1 (neutral)
* EAFE (EFA) – 53.5 (neutral)
* South Korea (EWY) – 14.6 (very oversold)

Commodity ETFs

* Gold (GLD) – 53.5 (neutral)

Ultra Extremes

* Small Cap Bear 3x (TZA) – 19.2 (very oversold)
* Small-Cap Bull 3x (TNA) – 80.1 (very overbought)
*UltraLong QQQQ (QLD) – 80.6 (very overbought)
* Ultra Long S&P 500 (SSO) – 80.2 (very overbought)
* Ultra Short S&P 500 (SDS) – 19.1 (very oversold)
* UltraShort 20+ Treasury (TBT) – 48.4 (neutral)

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Kindest,

Andy