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Using Technical Analysis as a tool in a Rules-based Investment Strategy

 

 Using Technical Analysis as a tool in a Rules-based Investment Strategy

A rules-based investment strategy acknowledges that the markets (and individual securities) make constant movements in price and uses methodical tools to monitor those price movements to identify trends and take advantage of them to improve long-term returns.  The best rules-based strategies help the investor hold their positions when the market or security is advancing and reduce exposure when they are slowing.  Any practical solution does not try to do this on every minor “blip” rather identifies larger trends and forces action when those longer-term trends change.

This article describes several tools rules-based investors can use to identify trend changes.

 

The chart above shows a red arrow when the Trend Momentum is going down and the rank crosses 0 from a bull market to a bear market. A green arrow is shown when the Trend Momentum is going up and the rank crosses 0 from a bear market to a bull market.

Market conditions were bullish (in a Bull Market) as of 2017-11-27. This meant traders and investors should consider trading with a Bullish bias by buying (going long) stocks, long ETF’s or Call Options. The rank of the Bull Market is 7.26 which indicates the then-current market conditions were Extreme so risk of a reversal was high. The Most recent prior Buy Signal came on Jun 8, 2016.

 

Short Term Market Timing Signals

 

The short term market timing portion, as shown in the chart above, shows a combination of all three indicators on one graph, the momentum, breadth and sentiment indicators. The red and green arrows on the chart above the indicator chart will show each time these indicators gave confirmation or confluence that meet the buy or sell criteria. When market conditions are at extreme levels this group of indicators will find reversal ranges. If you see multiple arrows stacked one on the other each represents the day that the confirmation signal was still in place. Sell Signals are generated when sentiment is above breadth and Breadth is above momentum and all are above 90. Buy signals are generated when momentum is lower than breadth, breadth is lower than sentiment and both breadth and momentum are lower than 40. Values shown for Momentum, Breadth and Sentiment on the above charts do not match those of the ones below, data has been normalized here. Evaluate those charts individually.

 

Momentum Indicator

The Momentum Indicator is currently at 158.45 indicating a bullish trend in stocks, but with extreme short term bearish risk. This means the short term risk of the current bullish trend reversing or stalling is very high. Extreme measures of this trend range are 140 to 200. This indicator’s trend cycle extremes take place every 3 to 6 months.

 

The vertical buy and sell lines will only show a new line if a subsequent buy or sell signal has already been generated. For example, the indicator may be showing that it is in the buy range but there will not be a new buy Signal vertical line on the chart if there has not yet been a sell signal.

Breadth Indicator

The Breadth Indicator is currently at 60.91 indicating the breadth of stocks moving higher is neutral. Risk of a trend reversal low. This means the current trend is likely to continue. Extreme measures of this trend range are 30 to 65. This indicator’s trend cycle extremes take place every 3 to 6 months.

The vertical buy and sell lines will only show a new line if a subsequent buy or sell signal has already been generated. For example, the indicator may be showing that it is in the buy range but there will not be a new buy Signal vertical line on the chart if there has not yet been a sell signal.

Sentiment Indicator

The Sentiment Indicator is currently at 100.00 indicating the sentiment in the stock market is showing extreme complacency. Risk of a long term bearish trend reversal is extreme. This means the current long term bullish trend is NOT likely to continue. Extreme measures of this trend range are 95 to 100. This indicator’s trend cycle extremes take place every 18 to 24 months.

The vertical buy and sell lines will only show a new line if a subsequent buy or sell signal has already been generated. For example, the indicator may be showing that it is in the buy range but there will not be a new buy Signal vertical line on the chart if there has not yet been a sell signal.