Don’t Look At Indicators In A Vacuum

I have been writing about the market and economy for the last 18 years now and I made a small mistake this past week. I made the mistake of making a trade based on one indicator and without considering other factors. Let me explain.

First, I have been doing this for so long that I have developed an overall market indicator of my own. I call it my market barometer as it lets me know how much upside pressure of downside pressure I can expect in the short-term. I started developing the barometer in 2008 and officially started recording and tracking it on January 1, 2009. A big negative reading suggests that downward pressure is likely while a big positive reading suggests upside pressure is likely.

On January 25, I got the biggest negative reading since October ’15. That was a pretty good warning about downside pressure, little did I know how at the time that it was going to be the beginning of a major short-term correction. That obviously wasn’t my mistake. The mistake was the spike there at the far right of the table.

On Wednesday, February 7, the barometer got the third highest reading it has ever had at 122.2. The only other readings that were higher came on July 6, 2010 (129.2) and November 28, 2011 (122.4). Both of those signals were pretty strong bullish signals in the short term and in the intermediate term. The one in July ’10 came just before a 9.7% one-month gain and 19.24% in four months. The one from November ’11 came just before a 6.1% one-month gain and 18.8% in four months.

Looking at the first instance I mentioned above, July ’10, we see that the S&P had been moving down for almost three months and the weekly stochastic readings were close to oversold levels.

On the second occasion that I mentioned above, November ’11, the S&P had also been trending lower, but only for about four weeks. The stochastic readings had barely had time to move out of overbought territory, but they were at least out of overbought territory.

Jumping ahead to the present situation, we see the high reading from my barometer on the current chart, but see some different scenarios from what we saw in the other two instances. First, the stochastic readings aren’t even fully out of overbought territory. The second item of note is that we have only seen two weeks of selling since the record high earlier this month.

In the opening of this article, I said I made a small mistake. Actually, I made two mistakes. My first mistake was when I got excited about the reading on the barometer being so high. As Gordon Gekko said in the movie Wall Street, “Don’t get emotional about stocks.” My second mistake was not considering the overall landscape of the market and how this high reading could be different from the other ones. I said it was a small mistake because I didn’t rush out and sell all of my bearish positions, that would have been a big mistake given yesterday’s selloff. I did however add another bullish position yesterday and it got hit pretty hard yesterday.

Will this high reading on the barometer be as successful as a signal as the other two? Maybe, but we will have to wait to see. Had I stopped to consider the overall market environment and looked at some other indicators, I probably wouldn’t have added the extra bullish position. With the market being so volatile these past few weeks, it is easy to act out of emotion and sell things in a panic and that is a common mistake and it is probably far more common than panic buying. However, panic buying can be just as dangerous as panic selling.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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