A picture is worth a thousand words…
As mentioned in the last update, our reversion to the mean of volatility was implying to me that a volatility spike was on the horizon and man-oh-man did we get one (the ATR graph near the bottom). The high volatility environment that the Wave Momentum indicator was predicting (bottom) also played out. Lastly, my free RSI Trend Cycle indicator noted that we should step out of the market on the 26th of September at the latest.
It’s funny how statistics and risk management act to protect you. On the 21st of September, I was stopped out of my main trade algo and quite annoyed. I thought perhaps my bot had a bug that I’d have to debug, the market seemed poised to reverse a little before moving forward to even greater heights (SPX3000!). Sure enough, the exit seems downright prophetic in hindsight, being only a few points from the peak.
Ironically enough, it was one of my simpler trading rules which triggered a stop and ultimately got me out of the market at near the peak. I have a simple rule I call “long bar” protection. It’s a simple rule where I check whether a “very long bar” or major move (as measured by standard deviation) is detected. If so, my algo moves my stop up to a percentage of that last bar (in this case it was around 20%). This is a rule that I primarily have active when markets are in a volatile phase and interestingly enough it tends to average out to the equivalent of the normal exit rules but with lower volatility. It’s a “take your money and run” type of tiny improvement that works because in general I trade momentum strategies that don’t revert midstream unless something has gone wrong. If they do revert midstream, often times the exit signal given by a strategy (when momentum has decreased) coincides with the same price level, a few days/weeks later.
Anyway, the major, eye-popping take away is that we not only blasted through the support line I drew last update, but we have continued on. This was a textbook sell on break of the support line (marked as 2877 on the last update) which is of course a support-resistance line created by the previous all-time high. This is an important psychological event. I can’t predict what will happen but I suspect many traders will look to the February decline and wonder if they’re once again going to see a year of trades/investments go down the drain.
The lower target for this decline would be in the 2500s. If you’re a trader, you should have been stopped or exited long ago. If you’re still in, you’re literally halfway between max pain and breaking even – not a great place for anyone (or their 401k) to be (not trading advice).
I am also kicking myself for not shorting the market. An old trading rule is if your trade fails to perform as expected, then it can be a powerful sign of the reverse happening.
Lastly, my Heaven and Hell indicator which fires red during every major decline has gone red. Typically that means at least a week of red if we’re lucky and up to several months of red + volatility if not.
Weekly RSI declining under 40 has historically been a market slowdown event preceding an acceleration and then a spectacular drop. While the future doesn’t mimic the past, it often rhymes with it. The market may ultimately resolve higher but there’s a lot of potential for serious decline given the number of concurrent long-term and short-term signals aligning for Bears.
I like to explain it like this — technical indicators are just that, indicators. Your car may blink “tire pressure low” and often times it can be ignored as being just due to weather changes but that one time it’s not, your tire will blow out. Similarly, market technical indicators don’t predict the future but they tell us there’s a chance of a certain condition or event occurring.
*** a note on trading the simple RSI Trend Strategy system shown above
1: RSIT moves from 0 upward are a BUY (first indicator shown above)
2: Use a volume trend to signal early exit. I prefer Weiss Wave (second indicator shown above). Optionally, exit on RSIT decline.
3. ATR or other volatility approximations can give you early warning of conditions (third indicator shown above)
4. The Wave Momentum Indicator I also gave away for free is most generally useful by simply looking at the background color. Green means you can be more risky on the long side, the bias is long, though beware of the internal green/red swaps (lines) – particularly as a green section gets longer and longer. Yellow means price action is choppy and may be signally a change in trend. Red indicates it will be hard to trade long – the bias is short.
I use simple rules like these to write automated trading strategies. I prefer automation because it takes the trader emotions out of the equation. You can find these simple free indicators below which might help improve your trading.
RSI Trend Cycle indicator – Free on TradingView
Wave momentum indicator – Free on TradingView