How Can You Identify Market Turning Points?

|
Includes: DIA, IWM, QQQ, SPY
by: Christopher DeMaria

Summary

A few charts to ponder before you sell everything.

The market reversal appears to have occurred on 01/11/2016.

The first follow-through day of said reversal appears to have occurred on 1/12/2016 and confirmation is needed.

Following a buy and sell discipline can alleviate the emotional aspects of when to buy and when to sell.

There's been quite a stir on Main Street this year as reminiscent echoes from the past appear. Financial pundits say to sell it all, except those Treasuries, before the great fall. Is anyone reminded of 2008 or 09? Maybe we won't recuperate this time. Alas, that familiar sound you can hear, a new market bottom must be near.

Candlestick chart of the S&P500 (01/12/2016) diagram below. Candlestick charts display the high, low, opening and closing prices for an index, or a security, for a period of time.

S&P500 daily chart

Candlestick chart of the S&P500 (01/12/2016 1 minute chart) diagram below. Candlestick charts display the high, low, opening and closing prices for an index, or a security, for a period of time.

S&P500 1 Minute Chart

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

Traditionally, Dow Theory sell signals are triggered on three developments: First, the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJT) must undergo a significant correction from new highs. Then, during the subsequent rally, one or both of the averages must fail to recover above their prior highs. Finally, both averages must fall below their prior correction lows.

My interpretation of Dow Theory suggests that the market registered a Dow Theory Sell Signal on August 25th 2015 when the DJIA and the DJT simultaneously broke down. Since that time, The DJT has continued to create lows while the DJIA has been more resilient. Consequently, the DJIA has failed to register new lows since the August and September correction in 2015. This indicates that only two of the three criteria have been met and the Dow Theory Sell Signal is not confirmed.

Some technicians are Interpreting that Dow Theory is registering a sell signal but, I think that as of January 13, 2016, it is still too early to tell. Despite Dow Theory, I still believe we are in a long term secular bull market and you can read more about that on a previously published article. This bull has a little bit more steam left.

Lower Risk Entry Point

My proprietary Market Risk Meter (I know it needs a better name) is once again registering a rare Lower Risk Entry Point. Day one of the reversal was 1/11/2016. The first follow-through day was recorded on 1/12/2016 and we are hoping to get a third and final confirmation over the next day or two. Despite what some of the other larger financial institutions are saying about selling, and short of any exogenous events, it is now time to pick the positions you want to buy. We could have follow-through confirmation as early as this afternoon. I have already begun purchasing long term and core positions (for clients with a strong risk tolerance) while looking for new leadership in the S&P 500 and Russell 1000 indices. Please note that more conservative investors should wait for confirmation. A strong follow through day with a market close above 1948 on the S&P 500 should suffice.

(click to enlarge) Market Risk MeterMarket Risk Meter Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

The Market Risk Indicator

I am a firm believer that many things will return to some sort of mean over time. When looking at the markets and risk, I prefer to view the ebbs and flows as ocean tides. When the tide comes in, per my methodology, risk is higher. Conversely, when the tide flows out, risk is lower. Although I cannot measure exactly when a correction or bounce will occur, I can tell you when there is more or less inherent risk in the market. I can also examine whether the tide has come in further than normal, (presenting greater risk) or gone out further than normal (providing us with rare lower-risk entry points)

More specifically, on the chart above, when risk rises above 20, it is time to begin trimming losers, taking some gains from winners in your portfolio and reviewing the types of positions you feel comfortable holding when things get ugly. If you're more of a long-term asset allocation investor, look at re-balancing your portfolio by shifting equity gains to other less correlated asset classes. You may also consider hedging strategies like selling calls, purchasing puts, or stop limit orders to try to mitigate risk.

When readings get below -20, hopefully you will have already identified your buy list of favorite mutual funds, equities, ETFs etc. because once you identify that high volume, high volatility, downside trading day coupled with a strong reversal and 1-2 days' follow through, you will now begin purchasing. Behind the scenes, you will be purchasing at prices that under normal rational conditions, investors would not be willing to sell for but once emotion is brought to the table and when others are panic selling the rules of logic are usually tossed out the window. It's like comparing an orderly fire drill to what really happens when there is a fire.

Those historical or even hysterical moments are like gems to the well trained and experienced money manager who is looking to buy but these events are rare. Seeing as the ideal buying opportunities do not present themselves very often, as evidenced by the fact that not every correction gets to -20 or lower on my risk measurement tool, there is a little more to discuss. Most purchases are actually made by identifying market reversals between the -10 and 0 levels on my diagram. I will continue to purchase some positions between 0 and 10 and rarely ever purchase anything above 10.

Comments about the Market Risk Meter

There are many variables that play a role in the very large equation, that drives the markets. I am not capable of knowing to what extent all these different variables impact the markets at any given moment. Sometimes employment numbers are the focus, other times political or social impacts drive the markets. In the end, who can identify the single most important culmination of variables in an adaptive model that is consistently accurate?

However, we can look at people, both socially and individually. Regardless of education, wealth, knowledge, or any other factor that may make a person seem wise, we can almost always count on people to react the same way when fear or greed sets in. No matter how many times we practice a fire drill, when a serious emergency presents itself, the exit is often not good. Although my methodology is by no means perfect, it is my best attempt to measure perception, emotion, and fear and greed, with the expectation that people will react the same as they have in the past. I doubt this will change until more people begin to put their faith in something greater.

Conclusion

Dow Theory as well as some financial pundits are warning that the market may get uglier but, by my interpretation, these suggestions have not been confirmed. We are very near to a "Lower Risk Entry Point" per the Market Risk Meter and should be able to confirm whether the current storm is intensifying or lifting, over the next day or two. Conversely, if we do not get confirmation, this correction may have some more sellers to shake out.

I personally believe that the storm is lifting. Consequently, a close above 1948 on the S&P 500 should confirm that the lower risk opportunity to enter the market has arrived.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: he information contained in this report or information provided does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation of an offer to buy or sell any security referred herein. Past performance may not be indicative of future result. Christopher DeMaria is registered with and securities offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Ste 1201, Fort Lauderdale, FL 33308 (954) 782-4771. Investment Advisory services are offered through Kovack Advisors, Inc. DeMaria Financial Services is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc. DeMaria Financial Services(941-812-0407) Themes: How Can Stocks: DIA, IWM, QQQ, SPY