Were you expecting this recent market plunge? Tom Demark’s Setup and Sequential indicators gave notice that the stock market uptrend was exhausted.
The Setup and Sequential indicators are major influences in the Hedge fund community. Pro traders speak of these as the ‘Holy Grail’ of market timing. Said to be close to 90% reliable, these signals show you when to buy into weakness and sell into strength.
I’ve devoted webpages to studying some of Demark’s most popular indicators, including Setup, Sequential, and Combo. It’s one of the more popular areas of the site. There you’ll find plenty of info on how to calculate these esoteric signals. But as a reminder:
A Sell Setup is where the Close is greater than the Close 4 periods earlier, for a minimum of 9 consecutive periods (the period can be daily/weekly/monthly). You can trade Setups by themselves, or wait for a more powerful Sequential or Combo signal.
A Sequential Sell signal begins on bar 9 of a Sell Setup, and is completed by 13 bars (do not have to be consecutive) where the Close is above the High of 2 periods prior. An ‘Aggressive Sequential’ is similar, but we compare the High vs High of 2 bars prior.
Spend some time looking at charts and reading my Tom Demark page and it will all come together 🙂
So lets look at a chart.
As explained on the chart, in May 2011, both an ‘Aggressive Sequential’ (which started from the 2009 Bear Market lows) and a new Setup gave us a powerful sell signal. (this year confirming the old “Sell in May and Go Away”). These signals were on a Monthly timeframe. The larger the timeframe the more important the signal (ie. Monthly is more significant that Weekly or Daily).
I don’t have a charting software that gives these signals automatically. That’s why I created my own ‘Trend Exhaustion’ spreadsheet.
Below is an image from the spreadsheet. This is a large image you can click on it to enlarge.
The second 9-Month Sell Setup completed May 2011 (cell M226) was a great time to get out of the market. At the very same time, an ‘Aggressive Sequential’ completed (cell BH226) which was a continuation from the Sell Setup signal that started in May 2009 (month #1 is cell M202).
Having these two sell signals complete the same month is extremely powerful. Demark’s beautiful “end of the trend” system gave us fair warning.
So what else can we learn from this?
How long will Market weakness last?
When a monthly Sell Setup is completed, you expect 1 to 4 months of market weakness (ie. in our case June, July, August and September 2011)
With a completed Aggressive Sequential Sell signal, you expect 1 to 12 months of market weakness (ie in our case a 1 year Bear market)
I believe the stock market fell so violently, so immediately, because both a new Setup and the Aggressive Sequential completed at the same time. This is rare on a Monthly timeframe.
How low will the Market go?
These particular Demark indicators are not meant to provide an exact answer to this question. Basically we should watch the trend and look for new completed indicators.
They do, however, give us guidance. With a completed Sell Setup, look for price to fall toward the true low of the Setup. For the Setup that completed in May 2011, that is 1050 on the S&P 500 – another 18% drop from today’s levels.
Is there any good news?
Yes, actually there is. The Setup that completed in May 2011 broke above prior resistance (the SPY etf had a Close above 132.5 – see column BM in the image above). When a Setup closes above resistance, you expect this same Setup to continue into a Sequential (or Combo) pattern.
For this reason, the Demark indicators give us a clue that this selloff could be short and sharp, followed by a move to new highs.
At least that’s my take, but you can bet I’ll be watching these indicators to see what comes next.
This Trend Exhaustion spreadsheet is available on my Research Offers page.
It’s make-or-break time on my Short trade. I went short the market, based on a TD Sequential signal, with a fair portion of my portfolio back in mid-September using inverse etf’s. Bad timing. Several of them are down 25%. My overall portfolio is down about 6-7% across the several accounts I trade thanks to great performance from my stocks. Though I’ve handily beaten the market over the past few years it still hurts to underperform during a bull run.
Bad risk management. I put too much into the trade, and I should have analyzed the TD Risk Level before going in. The Risk Level is calculated by finding the bar (week) with the highest high of the TD Countdown, and adding it’s range to it’s High. For this trade the high week was week of April 19th, and adding it’s range to it’s high gives 124.0 The chart below shows this:
Note: to confuse matters, the TD Risk Level is either 124.0 or 125.0 depending on which data service I use – whether a trade week ends on a Monday or Friday. Anyway, we are up to these levels now and if the market closes above them, the trade is off.
So it’s now make or break. But last week I broke a little, and sold off a few triple-inverse etf’s (CZI and DRV) at a 25% loss. 25% is a standard stop-loss many traders use. I’m still holding three remaining short etf’s and plan to until/unless the TD Risk Level is breached.
I should probably quit this Demark thing and stick to picking value stocks. Partially due to my intense study of Demark this summer, I missed a 70% return opportunity in Gymboree (GYMB) – see my last post. Picking good stocks at great prices has made plenty of investors wealthy and I’m pretty decent at it now.
But I know this. These Demark signals very often make fantastic calls. I see it in my spreadsheet on hundreds of stocks/etf’s I’ve studied. I just need to learn to be a better trader in order to use it.