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I've developed personal investing strategies for individual stocks and Asset Allocation: 1) Stocks - Fundamental value investor using Free Cash Flow as defined by Buffett's 1987 shareholder letter. Invest only in predictable, undervalued stocks with good management. Buy with a Margin of Safety,... More
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  • This Summer's Violent Selloff was predicted by Demark Setup/Sequential Indicators 0 comments
    Aug 26, 2011 10:53 PM | about stocks: SPY, IVV
    Were you expecting this recent market plunge?  Tom Demark's Setup and Sequential indicators gave notice that the stock market uptrend was exhausted.

    The Setup and Sequential indicators are major influences in the Hedge fund community. Pro traders speak of these as the ‘Holy Grail’ of market timing.  Said to be close to 90% reliable, these signals show you when to buy into weakness and sell into strength. 

    I've devoted a webpage to studying some of Demark's most popular indicators, including Setup, Sequential, and Combo.  You can find it here.  It's one of the more popular areas of the site.  There you'll find plenty of info on how to calculate these esoteric signals.  But as a reminder:

    A Sell Setup is where the Close is greater than the Close 4 periods earlier, for a minimum of 9 consecutive periods (the period can be daily/weekly/monthly).  You can trade Setups by themselves, or wait for a more powerful Sequential or Combo signal.

    A Sequential Sell signal begins on bar 9 of a Sell Setup, and is completed by 13 bars (do not have to be consecutive) where the Close is above the High of 2 periods prior.  An 'Aggressive Sequential' is similar, but we compare the High vs High of 2 bars prior.

    Spend some time looking at charts and reading my Tom Demark page and it will all come together :)

    So lets look at a chart.
    Demark Setup and Sequential Signals (Monthly timeframe)









    As explained on the chart, in May 2011, both an 'Aggressive Sequential' (which started from the 2009 Bear Market lows) and a new Setup gave us a powerful sell signal.  (this year confirming the old "Sell in May and Go Away").  These signals were on a Monthly timeframe.  The larger the timeframe the more important the signal (ie. Monthly is more significant that Weekly or Daily).

    I don't have a charting software that gives these signals automatically.  That's why I created my own 'Trend Exhaustion' spreadsheet.

    Below is an image from the spreadsheet.  This is a large image you may have to scroll around to see it all or click to enlarge.
    Excel Trend Exhaustion Spreadsheet, Demark Sequential, Demark Setup













    The second 9-Month Sell Setup completed May 2011 (cell M226) was a great time to get out of the market.  At the very same time, an 'Aggressive Sequential' completed (cell BH226) which was a continuation from the Sell Setup signal that started in May 2009 (month #1 is cell M202). 

    Having these two sell signals complete the same month is extremely powerful.  Demark's beautiful "end of the trend" system gave us fair warning.

    So what else can we learn from this?

    How long will Market weakness last?
    When a monthly Sell Setup is completed, you expect 1 to 4 months of market weakness (ie. in our case June, July, August and September 2011)

    With a completed Aggressive Sequential Sell signal, you expect 1 to 12 months of market weakness (ie in our case a 1 year Bear market)

    I believe the stock market fell so violently, so immediately, because both a new Setup and the Aggressive Sequential completed at the same time.  This is rare on a Monthly timeframe.

    How low will the Market go?
    These particular Demark indicators are not meant to provide an exact answer to this question.  Basically we should watch the trend and look for new completed indicators.

    They do, however, give us guidance. With a completed Sell Setup, look for price to fall toward the true low of the Setup.  For the Setup that completed in May 2011, that is 1050 on the S&P 500 - another 18% drop from today's levels. 

    Is there any good news?
    Yes, actually there is.  The Setup that completed in May 2011 broke above prior resistance (the SPY etf had a Close above 132.5 - see column BM in the image above).  When a Setup closes above resistance, you expect this same Setup to continue into a Sequential (or Combo) pattern.

    For this reason, the Demark indicators give us a clue that this selloff could be short and sharp, followed by a move to new highs.

    At least that's my take, but you can bet I'll be watching these indicators to see what comes next.

    This Trend Exhaustion spreadsheet is available on my Research Offers page.





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