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  • Five Charts That Say It Is Time To Sell 7 comments
    Apr 23, 2013 4:29 AM


    If you would like to track updates on the charts shown below sign up at, click on the verification email, and get SIX months access to my on-line newsletter for free!

    The bull/bear cycle highlights four distinct phases, based on risk, with each phase having its own trading characteristics, where one phase follows the next in a predictable manner, in a repeating circle of stock market ups and down as the economy expands and contracts.

    The green line in the first chart below shows average monthly returns for the NASDAQ Composite Index during the first of the four phases, low risk, new bull market underway. Think of the green line as the rally off the March, 2009 lows.

    Once complete, the up, up, and away! of new bull, low risk phases, are followed by the yellow line of sideways churn of the moderate risk phase, which is a corrective period post bull that sometimes morphs into a minor bear market, though moderate risk years generally end well for the bulls. Think of the yellow line as the volatile up and down churn we experienced in 2010.

    What is required to make money in the first phase fails to work in the second, and vice versa, which is the primary message of this bull/bear cycle chart. Each distinct phase requires traders and investors to adjust if they are to make money in the stock market.

    The orange line for High Risk - blow off bull - phases is the third part of the bull/bear cycle, which we have been in since mid-2011. High Risk - blow off bull - phases are very tricky to trade, as sometimes they last only a month or so (such as the summer of 1987,) while other times they can last many years (such as 1997/1998/1999, as well as 2005/2006/2007.)

    The black line tracks the trading action for the NASDAQ on a monthly closing basis in 2013. As you can see, that black line is tracking the orange High Risk - blow off bull - line very closely.

    The numbers 1 through 6 represent trading turns the stock market is expected to make in High Risk - blow off bull - phases, and thus this year.

    The average gain for trade 1 in High Risk phases is 10.8% by the end of April. The S&P500 hit a peak recently of 11.7%, with other indexes showing similarly impressive gains in-line with expectations. Thus the bull/bear cycle indicator says it is time to sell to lock in profits on trade 1 in anticipation of a swift and significant plunge in trade 2.

    Worse, what comes next in the bull/bear cycle is the red line of Extreme Risk phases, which are MAJOR bear markets along the lines of what we experienced post 1929, 1973, 1987, 2000, and 2007 peaks.

    Later in this article I will discuss the signs to look for that have historically confirmed the shift from High Risk - blow off bull - to Extreme risk - MAJOR bear, which may be of great value to longer term investors who try not to time shorter term swings, though still prefer to avoid the worst of the bear plunges.

    For now, the bull/bear cycle chart says stocks are positioned for a swift and significant plunge, and one having the potential to start the next MAJOR bear market.

    (click to enlarge)


    The third week of April shows the highest clustering of stock market peaks when in High Risk - blow-off bull - phases, and as we ran into that common reversal week last week the S&P500 was pulling back after kissing the upper trend-line of a potential expanding triangle, with the 2000 and 2007 peaks setting the upper trend-line, and 2002 and 2009 lows the lower. The dotted black line in the chart below represents the upper trend-line.

    Fundamentally, the economic data in April has been shockingly bad - here and abroad - with ISM manufacturing, unemployment, consumer sentiment, and retail sales all coming in far below expectations in the US, and close to recessionary levels. Indeed, the ongoing plunge in copper and other industrial commodities - matched with rapidly rising inventory levels of those products - suggests a global recession is fast sweeping around the world, despite so-called mega stimulus from central banks.

    My view on the latter is it would be stimulus if central bank money ever left the bank vaults, though it isn't, thus it isn't simulative. Ultimately, stocks will follow the economy, and if walking like a duck, quacking like duck, means it is a duck, then we are facing a major recessionary event in the non-too-distant future.

    Note how the yellow and red lines of ISM manufacturing and ISM employment in the chart below peaked in the summer of 2011, and have been weakening ever since.

    Note how a similar pullback in economic activity foreshadowed the 2007 peak that led to the 2008 stock market collapse and financial crises.

    Worse, the white line of active money manager sentiment (source at the bottom of the chart recently hit its highest level ever recorded. The red circles highlight such overly optimistic extremes since 2005, with the usual response a stock market plunge that saw active money manager sentiment crossing the overly pessimistic extreme (green circle.)

    Are worrisome technical signs, matched with weakening economic data, sub-par earnings growth this quarter - especially on the revenue side - while investors are overly bullish and overly exposed to stocks, a reason to hit the sell button to lock in profits on what has been a very impressive bull run this year? These charts say so, and it gets worse...

    (click to enlarge)


    The rally this year has been the weakest and sickest I have ever seen!

    Just look at all the red arrows in the confirmation/divergence chart below.

    White volume line - red arrow, as volume failed to confirm the rally this year.

    Olive colored line of SMH - red arrow, as SMH failed to confirm the breakout of other indexes.

    Green ADX line - red arrow, as the ADX trends down, while the yellow contrarian indicator line begins to fall from an overbought extreme.

    Blue New highs (as a percentage of total shares traded) line - red arrow, as the recent sell-off saw a collapse in the number of stocks making new highs, highlighting that individual stocks are acting much weaker than the indexes themselves.

    That leaves one green arrow highlighting how the Dow Transports led the 2013 rally breakout charge to start 2013, and while they have been struggling of late, the transports remains north of any serious breakdown. Ditto for the IAI broker line, where it first confirmed the breakout, though has been heading seriously south of late.

    Past healthy rallies that proved to be the real thing saw volume, the semis, the transports, the ADX, the brokers, and stocks as a percentage of total shares traded all confirming the breakout of the major stock indexes, including all rallies prior to the 2013 one since the 2009 low.

    Not only was the 2007 peak marred with similar divergences - and we all know how that turned out!- the 2009 lows also saw similar non-confirmation, only in the opposite direction, with many of those Big Kahuna leadership groups failing to break to new lows in March of that year - and we all know how that turned out!

    These divergences are a major warning that a change in trend from bull to bear is in the offing, if not already here.

    (click to enlarge)


    The two prime questions investors and traders have to ask and answer at any given time is whether to go with the current stock market trend, or take the contrarian view and trade against the trend.

    The current stock market trend is up. Should one be holding stocks in-line with the trend here, or is the stock market so overbought that investors and traders should be in cash, or even positioned on the short side of the tape?

    The chart below is my main trading weapon to answer those questions, with the upper indicator the one I follow when contrarian, bet-the-other-way, is called for, while the bottom indicator is what I use to signal when to add or remove exposure when following the trend.

    One simple rule of thumb to answer the trend following versus contrarian sell overbought, buy oversold, conundrum, is Welles Wilder's ADX line, which is shown in the main body of the chart.

    The ADX (average directional movement index) measures the strength of a trend, by either trending up or trending down.

    I use the weekly ADX line for the NASDAQ Composite Index for intermediate term trading, and the daily for shorter term trades.

    When the ADX is trending up - indicating strong momentum with the trend - I follow the trend-trading indicator at the bottom of the chart.

    When the ADX line is trending down - indicating weak momentum with the trend - I follow the contrarian indicators at the top of the chart, selling and shorting on overbought extremes, while covering shorts and buying stocks when the stock market rebounds from oversold territory.

    The blue circles highlight how the contrarian indicators can remain above the extreme overbought line for an extended period when the ADX is rising, while the red circles highlight what happens when the ADX turns lower while the contrarian indicators are overbought.

    Currently, the ADX is trending south - thus I'm following the contrarian indicator on top - having recently triggered a red circle sell signal as stocks fell from an overbought extreme.

    This new red circle sell signal says it is time to take profits on longs, sell stocks short, which I have recently done.

    (click to enlarge)


    The history of the bull/bear cycle shows High Risk - blow off bull - phases are ALWAYS followed by Extreme Risk conditions that include a MAJOR bear market, recession, and financial crises, once the blow-off period ends. Even the longer term investor class, who try not to time shorter term swings, though still prefer to avoid the worst of the bear plunges, need to be wary of this potential change in investment seasons.

    Yes, the central banks can prolong these blow-off periods, though all that does is make the crash coming out the other side all the more damaging to investors, for, as the saying goes, the bigger you are the harder you fall.

    The 2000-2002 and 2008 mega bears are perfect examples of central bank actions helping to set the conditions for a major calamity once the bubble building period reaches it zenith, as well as painfully highlighting how powerless they are at stopping financial wildfires once they start.

    All that is required to confirm the bull market has reached it zenith and the next Great Bear began - orange High Risk line morphing into the red Extreme risk line in the first chart above - is the big win for the bears, something they have failed to do on every corrective attempt since the rally began in early 2009.

    The chart below was designed to track the health of rallies and corrections when in High Risk - blow off bull - phases. The point of these comparison charts (I have one for each of the four phases of the bull/bear cycle) is to track the indicators at the top and bottom with what usually transpires during each phase of the bull/bear cycle.

    In this case, the current NASDAQ is compared with other high risk blow-off years of 1987 and 2007, though analysis is based on all prior high risk phases over the past century.

    The red and green circles show how the indicators cluster in specific portions of the chart, and offer a template of future expectations that can be used to help time trades.

    The prime question now that the white line of the contrarian indicator at the top of the chart has left those red circles and is slipping from an overbought extreme, is which of the rally phases have we just completed, the middle or final?

    If it's the former, we can expect another blow-off rally phase into the summer.

    If it's the latter, then all things go pear shaped and bear shaped in a hurry, as the bull run off the '09 lows turns into a BIG RED sell phase on par with what we experienced following the 2007 and 1987 blow-off rally peaks.

    We will know for sure once the white contrarian line reaches oversold extreme levels, and we get to see whether the ADX line is rising or falling.

    If the ADX is trending south by the time the stock market becomes oversold on the current sell wave, then we are likely in the middle rally position, and I would look to buy at that time, expecting one final breakout run to unfold going into the summer to mark the final rally.

    If the ADX line is trending north by the time the stock market becomes oversold, then the final rally is likely already complete, and I would look to hold short positions, expecting the white dotted of the trend indicator line (for short trades once trends turn negative - next week) to race into the yellow circle that represents the big win for the bears to confirm the bull market is over, and next BIG RED bear phase begun.

    (click to enlarge)


    There you have it. Five charts, five stories, all saying the same thing: sell now, buy in a few months, with the ultimate fate of 2013 held in the hands of how much downside momentum is generated on these corrective attempts.

    To those investors and traders who believe the bull has much further to run, despite history of the bull/bear cycle saying that is unlikely, I will leave you will with some sage words from one of the investments greats, Sir John Templeton, who warned us the four most dangerous words in investing are, "It's different this time."


    If you would like to track updates on those charts you can take a six month free trial to my alphaking newsletter. Simply sign up for the 30 day trial at, click on the verification email, and we will adjust to six months. I run four tracking portfolios - so lots of stocks to buy and sell! - as well as a 401K advisory for those looking to make and protect money in their retirement nest-egg.

    Disclosure: I am long PSQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Comments (7)
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  • mts
    , contributor
    Comments (162) | Send Message
    Thanks for sharing this. I know authors spend a lot of time getting an article to the point where we actually get to see it.


    At first glance I found chart#1 to be challenging and think that others may as well.


    Chart 1's title says it's "Average Monthly Returns..." so the horizontal axis is months? And the black line shows January 1 2013 through the day of the article?


    The text says we're following the orange line closely. So we're near point #2 and soon to be a point #3. The chart would then imply the "Average Monthly Returns" are still going to be positive, as it is above zero, maybe around 7 or 8. Are those percentages, no units on the y-axis.


    So maybe this isn't the monthly average of all "High Risk - blow off bull" phase for each month but the average YTD return through that month of all "High Risk - blow off bull" phases.


    If somebody looked at the title and lack of x-axis, the orange line shows *all* positive average monthly returns. I doubt that's what the chart really means. The averages would be too high. It implies you should stay invested the whole year ;) If I thought the average return over the next month would be 7% - 8%. Why exit?


    Maybe it was instantly clear to everybody else but for me it sure would be nice to have an x-axis, y-axis units and a title which reflects that it's average YTD returns not "Average Monthly Returns" values.


    And if it's not average YTD returns, then that just shows that the chart is hard to understand.
    27 Apr 2013, 09:01 AM Reply Like
  • Kevin Wilde
    , contributor
    Comments (85) | Send Message
    Author’s reply » That high risk line is a bit deceiving, because A) it doesn't give justice to the verocity of those corrective plunges, since it is based on end of month data only, with extreme high and lows removed, and B) as the article pointed out, high risk can turn to extreme risk at any point in that chart. That chart, and the last one that goes into greater detail of high risk years, shows the two corrective swoons to be very tricky for traders, as A) the swoons are swift, and B) if the bears score a big win it is game over the bulls, and C) those big wins for the bears often come with crashes of some signficance. 2011 and 2012 also were high risk blow off bull years, and we now know those ended well (just as 1997, 1998, and 1999 ended well - only to be followed by 2000 - just as 2005, 2006, and 2007 ended well, only to be followed by 2008.) Who would want to hold onto stocks during those years during the violent corrective swoons during those years? Especially since the year is not guananteed to end well, with the next Great Bear starting the first time bears secure a big win?
    27 Apr 2013, 09:34 AM Reply Like
  • AllStreets
    , contributor
    Comments (1497) | Send Message
    Brilliant analysis. Another warning sign is the summation index which has trended down from overbought +1100+ for several weeks. On minor rallies it has not achieved new highs as the market has hit new highs and is still in intermediate overbought territory at +750. Meanwhile the shorter term McClellan oscillator has varied from -40/-50 on corrections to +25/+40 on rallies, a frequent topping area except on major impulse waves upward, and turned down on Friday from about +40. It appears that all the marginal index buyers of the last two months may be disappointed within a few weeks. If you imagine a grinding type correction to close the January gap at 142, that's going to leave an awful lot of overhead resistance behind and threaten the positions of many buyers of the last three years in the 140's. This could snowball into a major bear like the metal sector from 2011.
    27 Apr 2013, 10:09 AM Reply Like
  • Kevin Wilde
    , contributor
    Comments (85) | Send Message
    Author’s reply » On the McCellan - NYMO - kissing the upper bollinger band, thus signaling market very overbought in the short term, suggesting a reversal and sell off is imminent.
    27 Apr 2013, 01:46 PM Reply Like
  • turtleuofs
    , contributor
    Comments (434) | Send Message
    Great article, thanks. However, some graphs are difficult to comprehend. As mts noted, x and y axis labels would help this. Nothing about the first chart screams that "stocks are positioned for a swift and significant plunge" to me, but maybe I'm reading it wrong..


    Just out of curiosity what are you using to make the determination of risk level? I mean, if someone had said on March 9th 2009 (or whenever the exact low was) 'OK We're back in the green low risk phase' wouldn't everyone have been all in? Wasn't the reason the market crashed precisely because there was much more risk in the system than originally imagined?


    My only problem with charts is also that it ignores Central Bank action, and plenty of other macro variables. Nowhere in past data were the central banks of the world monetizing hundreds of billions per month. Therefore couldn't you say there is literally no historical precedent for the current market situation we're in?
    30 Apr 2013, 03:16 PM Reply Like
  • Joe2922
    , contributor
    Comments (486) | Send Message
    Turtle, the charts are hard to understand fully, I signed up for the AlphaKing newsletters, where he explains each one, a different one each weekday, and what they mean. When to follow the trend, when to be wary of it, go to cash or short. Short term and long term stuff.
    9 May 2013, 07:42 AM Reply Like
  • Kevin Wilde
    , contributor
    Comments (85) | Send Message
    Author’s reply » I use an indicator that has tracked every bull and bear market over the past century, and yes it said point blank to buy in early 2009, and confirmed the rally off the 09 lows had ended the prior bear to start the next bull.


    Now we are in position to start the next Great Bear.


    That indicator takes into account FED action, which is how High Risk - blow off - bull phases come about!!!!! They provide too much stimulus, investors become giddy, and buy the dip crowd keeps prices higher than they should be, preventing the normal cleansing of prolonged corrective periods.


    It is the FED then, and investor stupidity (overly bullish sentiment in more traditional name calling), that gives us the high risk blow off periods that lead to the worst bear markets and financial crises in history.


    Note how the orange line in the #2 position is near the high for the year!!! and the bear market can start on any of those corrections that come this year!!! which is why it is better to lock in profits than suffer the gut-wrenching churn that is surely coming our way.


    Remember the FED failed to stop the churn of 2010, 2011, and 2012, just as they failed to stop the collapses that come once the blow off period end.


    Remember to sign up for the 6 month free trial so you can follow the bull/bear cycle in real time.
    1 May 2013, 09:43 AM Reply Like
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