Best Stock Market Indicator Ever:
Rises to 85%; Secondaries Are Negative
Note from dshort: John Carlucci has switched to weekly data for the OEXA system. His latest updates are now posted here.
The $OEXA200R (the percentage of S&P 100 stocks above their 200 DMA) is a technical indicator available on StockCharts.com used to find the "sweet spot" time period in the market when you have the best chance of making money.
The weekly charts below are current through the week's close.
As of June 17, the criteria for the OEXA system have been modified to get a more accurate indication of market conditions. The new methods are detailed in the section below entitled "Background on How I Use This Indicator". Note that I have also switched from monthly to weekly OEXA200R and S&P charts for increased precision.
Weekly OEXA200R vs. S&P Comparison
According to the new criteria explained in the section "Background on How I Use This Indicator", green vertical lines indicate market entry points, red indicate exit points.
According to this system, the market is now Un-tradable. The signal for an exit came on June 10 when two of the secondary indicators turned negative.
The OEXA200R closed Friday at 85%, up four percent from last Friday's close.
Of the three secondary indicators:
- RSI is NEGATIVE (below 50).
- MACD is NEGATIVE (black line below red).
- Slow STO is NEGATIVE (red line above black).
A thought experiment...
Just about everyone expects a short term correction at this point, but what about the long term? We might get some idea by looking at where the market is today in relation to its long term trend. As you can see in the chart below, the S&P is 65% above the 140 year mean. For it to revert just to the mean would require a drop to approximately 1000. However, when any system is thrown out of balance it first compensates in the opposite direction before settling back to equilibrium. This means that we could see a far greater drop as the S&P falls from its high in 2000.
It is interesting to note that on this logarithmic chart the slopes from the three previous highs to lows are all exactly 34 degrees. Since the slope lines could have fallen anywhere between horizontal (45 degrees) and vertical (180 degrees) along a 45 degree arc, the odds of all three just happening to be exactly 34 degrees are 91,125 to one. One of my readers kindly pointed out that 34 is also a Fibonacci sequence number, something I was completely unaware of. If this is all just a coincidence, it's a very unlikely and curious one. If anyone with a mathematical background has any ideas, please share them with us!
Dropping a 34 degree slope line from the 2000 peak indicates that the S&P is above the mean for the current secular bear as well as the 140 year trend. In other words, it's doubly "top heavy". As the market counter-balances from the 2000 high a couple of possibilities arise. If it drops to the level of previous moderate bottoms represented by the green line we see the secular bear ending at S&P 500 in 2023 (green arrow). If it drops to the level of the all time 1932 low represented by the blue line we see S&P at 400 in 2026. Remember that the S&P crashed to "just" 666 in 2009. Since the 2000 high was the all time extreme variance from the trend at 153% it is not unreasonable to imagine an extreme over-compensation to the 400 estimate, as unpleasant as that would be. These scenarios seem much more likely than the S&P gently landing on and following the mean line, let alone suddenly making a u-turn and taking off into a multi-year bull. They also mesh with demographic trends that Doug Short has previously examined. Not that past is always precedent, but we could be in for a long slog.
Background on How I Use This Indicator
The OEXA200R is a valuable metric used to accurately assess the state of the market in order to make profitable trading decisions. That is, whether we are in a bull, a bear or transitioning from one to the other, as well as market volatility and risk within each of those situations. Historically, it has also given traders a clear early warning signal of impending serious market downturns and later safe re-entry points. While not intended as a day trading tool per se it can certainly be used as background information by day or highly speculative traders. Simply put, the OEXA200R gives traders the ability to identify the most opportune conditions within which to execute their various long, short or hold strategies.
Definition of Terms:
"Tradable" refers to the point at which it is most advantageous to enter and continue long trading.
"Un-tradable" refers to the point at which it is advisable to exit all long positions that have not already automatically closed with a trailing stop loss. Please be aware that the OEXA exit points are not always timed at the exact top of any run up, that is impossible to predict. However, a trailing stop will follow the price to the highest point and close out as it falls from there, meaning most positions should have closed before the OEXA exit signal appears and thus should close at a point higher than at the exit signal.
Following a major market correction, the conditions for safe re-entry are when:
a) Daily $OEXA200R rises above 65% (I follow the Daily but do not publish the chart here)And two of the following three also occur:
b) Weekly RSI rises over 50
c) Weekly MACD black line rises above red line
d) Weekly Slow STO black line rises above red line
Without the solid foundational support of two out of three Weekly secondary indicators it is unsafe to trade even if Daily OEXA200R edges above the 65% line. The market is considered safely tradable as long as Daily OEXA200R remains above 65% and two Weekly secondary indicators remain positive. Volatility and risk for long traders are relatively low. The trend is on their side.
Conversely, when Daily OEXA200R drops to 65% and / or two out of three Weekly secondary indicators turn negative it is taken as the conservative signal to exit all long positions, even if Daily OEXA is above 65%, as is the case now (June 24, 2013). Volatility and risk increase substantially. In the past, this has often been a "tipping point" condition presaging a substantial market drop.
It might sound confusing but just look for the notice in the "Interpretation" section above as to whether the market is simply either "Tradable" or "Un-tradable". In the future, when either of these entry or exit conditions occurs I will do a flash update the same day posted on Advisor Perspectives.
If the OEXA200R does not rebound but remains below 65%, how to proceed depends on the overall trend of the market. During the cyclical bull of 2003 to 2007, the market was still safely tradable with OEXA200R in the 50% to 65% zone because there was enough upwelling lift in the S&P at that time to minimize the chance of a sharp, significant market downturn.
The problem is that we can by no means confidently compare our present situation to that of 2003 – 2007. There is no strong, steady wind pointing the market weathervane in one direction, it is being buffeted by swirls and gusts in unpredictable ways. To better understand this, take a look at the charts below, in particular the overall trend of the OEXA200R during the 2003 – 2007 cyclical bull compared to the trend from 2007 to present.
S&P chart indicates that for the past five years we have not had a steady upwelling trend in the market comparable to 2003 – 2007. Absent that underlying support, the OEXA200R has undergone significant gyrations since 2007. This erratic behavior has only been exacerbated by the Fed's deliberate manipulation which has distorted normal organic market price movement. Notice also that even in spite of the Fed-fueled rally, the S&P volume has experienced a steady decline since 2009, a Bear indicator of "main street" investors taking flight.
If the OEXA200R drops below the 50% line we regain clarity as to the market's direction. That will be the strong signal of a serious, imminent market decline. It will also be the clear signal for short traders to take advantage of that sharp decline.
Long Term Performance of the OEXA System
For a hypothetical "trade" of the S&P 500 Index, a single Buy and Hold entered on July 13, 2009 and exiting on June 10, 2013 would have generated a 72.98% total return with an 18.24% average gain per year. The OEXA system would have produced an 82.96% total return with a 20.74% average gain per year after 8 compounded trades.
A single Buy and Hold trade entered on April 28, 2003 and exiting on October 15, 2007 would have generated a 61.29% total return with a 13.62% average gain per year. The OEXA system would have produced a 40.65% total return with a 9.04% average gain per year after 8 compounded trades.
By regularly exiting in an advantageous manner at market tops OEXA avoids the equity destruction suffered by Buy and Hold investors in downturns, especially during severe drops. After their 2007 exit OEXA traders would have been able to resume in 2009 with their accounts fully intact, unlike many other unfortunate souls. You might think that having a clear exit strategy for a downturn is plain common sense but the $6.9 trillion loss investors suffered in the 2008 crash says otherwise.
By exiting at opportune points and engaging in multiple compounded trades, from April 28, 2003 to June 10, 2013 OEXA returned 259.99% (26% avg. per year over 10 years) vs. Buy and Hold 74.84% (7.48% avg. per year over 10 years). Of course, these raw numbers are affected by capital gains tax, dividends, inflation, etc. but the concept remains the same.
(c) John F. Carlucci