T2108 Update – September 23, 2011 (A Summary of T2108’s Performance)

(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag.)

T2108 Status: 19.5% (second day of oversold conditions)
VIX Status: 41
General (Short-term) Trading Call: Continue closing out bearish positions. Aggressive traders should already have established new bullish positions.

Commentary
The S&P 500 managed to hold its ground with a 0.6% gain. Support at the 2011 closing lows survives for now. Similarly, the top of the range for the VIX holds for now. With T2108 on its second day in oversold territory, I would declare that the market is ready to sustain a rally. However, with many global markets in bear market territory, and the S&P 500 on the edge of one, I have to be more circumspect.

The closing and intra-day lows for 2011 stand out again as “obvious” support. So, we should fully expect market manipulators, uh , makers, to probe for stops. Assuming these lows get snapped, I will immediately look to see the reaction in the VIX. If volatility spikes at least 20% in response, I will assume that the stock market is closer to a bottom – I will add to bullish positions and dump whatever bearish positions remain in the portfolio (including hedges). Otherwise, I will just continue to hold.

It was not a placid day for commodities. Of particular interest, gold, and especially silver, sold off hard. I am looking forward to fresh buying opportunities in both. I address this topic in another posting: “Buying Opportunity Brewing For Gold, Silver As U.S. Dollar Picks Up Steam.” I will also soon update where I stand on the commodity crash playbook

Finally, I want to address a tweet I received on Friday from @Trader3585: “this oversold business may make you money 99 times but the one time it does not work it will take your last 1000 rounds of money.” This is a standard warning that applies to anyone who does not practice risk management and abuses leverage when executing a trading strategy. In my extensive study on playing T2108 for oversold trades, “Trade the Oversold Bounce” (free registration required), I took into account historical drawdowns to develop the rules for trading oversold conditions.

IF this method actually produced winners 99% of the time, I would be ecstatic! As things stand now, every oversold period has eventually ended. Before the oversold periods of 2010 and 2011, 37 of 52 oversold periods (71%) ended with a positive return when comparing the close of the first day of the oversold period and the close of the day that marks the end of the oversold period (I need to update last year’s study). The worst drawdown was an almost 20% loss following the crash of 1987. Nothing else has even come close. Moreover, simply continuing to hold after the 1987 oversold period ended would have eventually netted very large positive returns. Note well that the conservative strategy was specifically designed for anyone who cannot tolerate large drawdowns.

Weekly T2108

*T2108 charts created using freestockcharts.com

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SSO