(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-related trades and other trades are posted on twitter using the #120trade hashtag)
T2108 Status: 87% (overbought day #26)
VIX Status: 18.2
General (Short-term) Trading Call: Close more bullish positions. Begin but do NOT expand an existing bearish position.
Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
Commentary
Day #26 for this historical overbought period – the top 8% of all overbought periods since 1986 and one of the best performing at this point in time in the cycle. The S&P 500 continues to linger agonizingly directly below fresh multi-year highs.
I have finally taken some time to extend my analysis of overbought periods into what happens in between overbought periods. I will eventually dedicate a post to the complete analysis, but in the meantime I wanted to share some preliminary results.
The chart below is a scatter plot showing the maximum loss in the S&P 500 between overbought periods indexed by the duration of the preceding overbought period. In other words, this is an attempt to answer the following question: “what is the maximum correction a trader might expect after this current overbought period ends?”
First, notice that there is no correlation between the duration of the overbought period and the maximum loss that follows its end. Also notice that in SOME cases, the maximum “loss” is actually a gain! Returns are measured from the close of the day the overbought period ends.
I would describe the chart as having three distinct areas.
- Area 1: In the vast majority of cases, the sell-offs following overbought periods are shallow, less than 10%. The shorter the duration, the more performance clusters but also the longer the tail.
- Area 2: After about 20 days (like the current overbought period), the maximum loss after overbought conditions end is 10%. It seems just as likely for the maximum loss to be 0% as it is to be 7 or 8%.
- Area 3: All the major corrections followed overbought periods lasting less than 20 days. The worst sell-offs clustered around the average duration of 9 days.
So, if history is any guide, the correction from this overbought period will be “modest.” In other words, do not expect a bear market to follow. It is much more likely the rally will resume after a period of time. (The average duration between overbought periods is 31 days, the median is 7 days).
My complete analysis will show some other interesting results: for example, the number of days between overbought periods is not highly correlated to the maximum loss during this time. After removing any periods that included oversold conditions, the correlation improves somewhat up to 50 days.
Stay tuned for more!
Charts below are the latest snapshots of T2108 (and the S&P 500)
Refresh browser if the charts are the same as the last T2108 update.
Daily T2108 vs the S&P 500
Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Weekly T2108
*All charts created using freestockcharts.com unless otherwise stated
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 SDS and VXX; net short euro, long AUD/JPY, FXA, long RSH calls, long BBY shares
First blush reaction is “why bother” to trade off 2108 as it seems to validate a buy and hold approach; i.e., overwhelming majority of corrections are 5-6% or less. If that is too imprecise, then second blush says to use 2108 you gotta be very quick and bold in catching the bottoms.
On the other hand, buyinng when 2108 goes above 30% after going below it would probably help one avoid the Black Swans ala 2008. Which makes me want you to do a study where the above is juxtaposed with the 5 broad phases of the market (e.g., accumulation, distribution etc.).
Interested in your further takes on the above and thanks again for all your hard work and sharing.
Well, I would qualify your observation a bit. If you are only interested in long-term investing, do not bother with T2108 until the market sells off. Use T2108 to fine-tune your regular purchases of stock. Definitely do not use T2108 to time stock sales, use your age, point in your career, financial goals, etc..
Now, if you are a short-term trader (or using short-term trades to supplement your investing), I think T2108 has plenty to say both on sell-offs and massive rallies. I think it is VERY useful to have an indicator that can confirm the high likelihood of sustained momentum and/or low downside risks after a strong move up. And there is a LOT to be said to using T2108 to avoid massive drawdowns, preserving capital for better buying points.
I will be hard-pressed to mathematically/quantitatively define the stages of accumulation, distribution, etc… I know there are other technical indicators that try to do this, but I try to keep my toolkit very simple.
I hope the clears things up. As always, thanks for the feedback. I can’t wait to get your reaction to my complete study. I hope to finish it this weekend. Stay tuned!