Well the objective of this post is to backtest a simple market reversal indicator to idenfity market tops in bull markets. Or in plain words timing the exit from the Bull market.
After going through last years market crashes where Indian markets key indices fell 60% , the Sensex -fell from peak of ~20,000 to 8,000 and NIFTY fell from 6200 to 2500, I did a `technical` study. I gone through the charts and observed that in end 2007, when most global markets were at their peak levels, the gap ( or spread) between the current price and the 200 DMA (simple days moving average) was unusually large. For the India NIFTY index the peak spread was ~ 40%.
Now like most technical indicators suggest markets can remain overbought or oversold for weeks or months.
So to capture the duration of overbought period, I added another filter which is consecutive trading days where the 200 DMA spread was above +30%.
Then when the spread went below this level +30% , I then measured the NIFTY performance 1 month , 2 months and 3 months later. The results are given below in the table.
The period taken is from 1993 to till date or 4600 trading days or 18 years.
The table shows that
- Market toppish 200 DMA spread indicator occurs rarely - In the past 18 years , the pattern has been observed only 12 times or around once every 1.5 years.
- After hitting peak spreads, markets fall sharply over the next 1 to 3 months. The market falls from peak levels 15%,17% and 24% - 1 month later , 2 months and 3 month later respectively
- Clear evidence of Mean Reversion to the 200 DMA - The 200 DMA spread drops of peak 200 DMA spread of 38% to 13%, 6% and 0% -1 month later , 2 months and 3 month later respectively
Disclosure - short NIFTY and some Indian large caps since the last 1 week.