While recent Market action has been difficult to call 'timing' wise, it's not been impossible using relatively simple technical tools. Price action, the Relative Strength Index and my 'Sentiment' model have been jointly useful. It's all in how you use these tools and seeing bullish/bearish 'set ups' before or as they happen in terms of spotting trend reversals
. Moreover, it's the use of the same simple indicators over time that will tend to result in the best market timing.
I should clarify that my equities call to put daily volume ratio has been most useful when this technical model 'confirms' bullish or bearish price and RSI chart patterns.
FIBONACCI NUMBERS USED IN INDICATORS
I suggest using the Fibonacci number sequence for moving average and indicator 'length' settings in most cases. The Fib numbers are those that are the sum of the prior two numbers; i.e., 1, 3, 5, 8, 13, 21, 34, 55, etc. Let me clarify, that I use 5, 8, 13, and 21 mostly and use the 'standard' 50 and 200-day moving averages that are used commonly with stocks. For TRADING purposes I use numbers through 21.
5: I measure my daily equities call to put volume ratio numbers on a 5-day moving average basis in addition paying attention to the 1-day extremes.
8: I use as my 'length' setting for the Relative Strength Index or RSI on weekly charts.
13: For the 'length' setting of the Relative Strength Index or RSI on daily charts.
21: I use as a moving average length on hourly AND daily charts. I won't demonstrate the use of 21-hour and 21-day averages in this article.
That's it. Simple instructions for length settings but it does take some experience in putting together price action, indicators and sentiment 'set ups' that suggest trend reversals.
USE OF THE 8-WEEK RSI:
This indicator has been one of the best technical indicators to suggest the kind of overbought or oversold extremes that lead to reversals that have the biggest moves that follow these type extremes. However, very FEW traders wait for JUST these overbought or oversold extremes to develop and then trade contrary to the prior trend. It's ironic as the most money in options can be made this way, but it's not hardly in the nature of traders who like action to play this kind of waiting game.
I will highlight some of the recent price swings relative to RSI indicator extremes, starting with the weekly Nasdaq Composite chart (COMP); the Nas 100 Index options would be the trading vehicle of choice. I tend to prefer using the broader Composite index for TIMING purposes as there are less 'false' signals so to speak.
I've highlighted various extremes seen in the 8-week RSI going back a year or so and given them numbers for easy reference. I should first mention the use of Fibonacci Retracements of 38, 50, and 62%. I also sometimes make use of the 25 and 75% retracements of a prior move. I'll have more on retracements after making comments on the RSI below my first weekly chart.
EXAMPLES 1-7 above of 8-week RSI high/low extremes:
1: Tradable top coincides with an 'overbought' extreme.
2: Tradable bottom coincides with an 'oversold' extreme.
3: An early/premature 'signal' could be disregarded as price action didn't concur; specifically, no trendline break.
Example 4 & 5: More premature overbought 'signals', with no corresponding (downside) penetration of the up trendline. Price action doesn't concur here and is VERY CHARACTERISTIC OF TOPS as bull trends get overbought and stay overbought. Tops in stock indexes can be difficult to catch with right timing for put purchases or other bearish plays.
6: A more solid 'short signal' as price action concurred with a touch to resistance implied by the previously broken up trendline.
Examples 7 & 8 above: There was a bottoming 'set up' in my number 7 example, followed by what appears to be a secondary buy 'signal' occurring in the current week (of 9/5/11). I highlighted the factors I felt were suggesting an INITIAL bottom in my 8/12/11 Trader's Corner article. I say a bottom was setting up because of both the oversold condition suggested by the low in the 8-week/2-month Relative Strength Index AND by the higher low made in the current week. Price action combined with the oversold can be an unbeatable buy indication. Oversold extremes within long-term bull markets are usually more trustworthy as a buy signal than seeing an overbought extreme at tops.
STAIR STEP LOWS:
One of the signs of a market or stock that has bottomed after a steep decline is the pattern of 'stair-step' lows from the lowest low to the most recent. This is the situation seen next below on the daily chart of the Nasdaq Composite (COMP). The lowest low around 2330 was accompanied by an oversold extreme in the 13-day RSI. Extremes in the 13-day RSI has been in my experience an even more accurate way of measuring major extremes and subsequent reversal points, than is the case with the 8-week RSI.
3-Day RSI Patterns:
In 6 out of 6 instances seen below, 13-day Relative Strength Index extremes, accurately forecast an intermediate trend reversal. In two instances the oversold extremes were 'secondary' or ancillary suggestions of COMP being at a bottom.
In 3 instances, namely the first top and then the two tradable bottoms that followed in June and again in August, this extreme was 'confirmed' so to speak by a similar extreme in my CPRATIO 'sentiment' indicator.
RETRACEMENTS RELATED TO A POSSIBLE BOTTOM
The use of the common trend retracements of a Fibonacci 38, 50 and 62 percent are common. I also sometimes use what WD Gann suggested, which is to measure the 1/4, 1/3rd, 2/3rds and 3/4ths (or 25, 33, 66 and 75%) retracements also. I especially favor measuring the 66% or 2/3rds retracement levels of a prior price swing. However, if the 66% retracement level is exceeded in a very volatile market, I'll add the 75% retracement, in this case to my weekly chart seen below. If a retracement exceeds 66 to 75% it's likely going to make a 'round-turn' retracement back to re-test the prior low(s); i.e., a 100% retracement.
In the recent case of the hammering taken by the S&P (not so much with key high tech Nasdaq segments), the low to date is equal to a 75% retracement to the 1100 area. The rebound from this retracement level was a definite addition to the bullish turnaround potential suggested by a longer-term oversold in the 8-week RSI, the Head & Shoulder's downside objective, the extreme spike in VIX as well as the final build-up to a bearish sentiment extreme as seen in my second graphic above of the SPX daily chart.
I'll follow my Weekly SPX chart with some comments relating to the highlights I've made relating to action in the 8-week RSI.
There are generally as many or more' early' top signals as there are ones that accurately reflect an impending (downside) reversal. The second 'overbought' extreme seen above was the one where a tradable decline began of around 2000 points. The next extreme was an RSI low and represented a solid buy signal, along with a Head & Shoulder's bottom and just bottoming action in general; the last low above the lowest. (Our most recent RSI low also looks like another bottom signal as it's been accompanied by rising stair-step lows.)
A series of three 8-week RSI extremes were seen in above in late-2010/early-2011 at or above the 'overbought' zone (I've defined on the chart); i.e., 3 extremes suggesting the market was vulnerable to a downside reversal. The third extreme looked valid once the up trendline was pierced. Put positions bought there would have worked eventually if you had gone out far enough on the contract expiration. However, the GOLDEN opportunity came when SPX ran up to resistance implied by the previously broken up trendline AND the RSI didn't confirm the higher high made in the S&P. This set up a bearish Price/RSI divergence which preceded a very steep sell off over the 15 weeks that followed and a reason to not go too short-term in your options choices when using a longer-term weekly indicator as a significant criteria for entry.
My next and last chart of the DAILY S&P 500 has, as seen with the COMP daily chart above, 13-day RSI extremes that very accurately forecast an upside, downside and an apparent recent upside reversal. The two imminent upside reversals were also suggested by oversold type bearish extremes in my trader sentiment model.
Bullish price patterns are needed to suggest a recovery rally and there are two recent 1-day patterns I've highlighted on the SPX chart: one of a key upside reversal (a lower low, followed by a decisive upside rebound that closes above the prior daily Close and the other similar type action of just a very strong recovery move off the low. On both days there seemed to be a 'pull' or attraction back to the 21-day moving average, which is a bullish plus.
GOOD TRADING SUCCESS!