Seeking Alpha

E-Mini S&P 500: Where Are The Mean Reversion Trigger Points?

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Includes: IVV, SH, SPHD, SPY, VOO, VXX
by: Equity Management Academy
Equity Management Academy
Research analyst, gold & precious metals, commodities, ETF investing
Summary

With the E-mini S&P closing at 2414, we came into this week with a bearish trend momentum.

For the weekly price momentum since the market closed below 2480 at 2414, the sentiment of the market was also bearish coming into this week.

The signal went long from 2343 with the target of 2480 in the weekly report, and now we're back to neutral, waiting for the price to dictate the next trade.

A close above 2480 would activate the bullish trend momentum of the market once again and activate a sell 1 (S1) target of 2550 and sell 2 (S2)of 2687.

The extreme below the mean of 2480 is at the B1 level of 2343, with B2 at 2272.

This is the Variable Changing Price Momentum Indicator (VC PMI) Special Weekly Review of the E-mini S&P 500 for December 27, 2018. I offer a contrarian technical analysis based on the principle of reversion to the mean embodied in the Equity Management Academy's artificial intelligence algorithm, the VC PMI.

E-Mini S&P: Bearish Trend Momentum

This holiday week we have experienced a tremendous amount of volatility. However, the E-Mini S&P Weekly Report I published in Seeking Alpha's Marketplace under my Mean Reversion service on November 28 gave us a pretty good idea of how to manage this type of volatility. With the E-mini S&P closing at 2414, it gave us pretty good indication that as we came into this week we had a bearish trend momentum due to the fact that the 9-day moving average at 2665 is higher than the close of 2414. That meant we had a bearish trend momentum coming into this week. This analysis is one of the filters that we use to identify the momentum of the market on a daily, weekly and monthly basis, and which the VC PMI uses to automate and process market signals. I am trying to show you the components of the VC PMI in terms of its artificial intelligence.

Courtesy: ema2trade.com

A Contrarian System

Since the VC PMI is based on the principle of reversion to the mean, it is a contrarian system in relation to most trend-following systems. After many years in the business, I've learned that the volatility or price of a financial instrument tends to move its relative implied volatility to extreme levels. Once we can identify the average price or mean, whether on a daily, weekly or monthly basis, we can begin to extrapolate the potential relative extreme implied volatility above and below that mean. With the methodology of the VC PMI's artificial intelligence in place, the algorithm identifies for us extreme levels above and below the market with high probabilities, which were a reversion to the mean in terms of price are highly likely to occur. The methodology that we teach our subscribers at the Equity Management Academy is focused on how to identify the trigger points when the price reaches and activates any of these extreme levels above and below the current average price.

Weekly Price Momentum

Courtesy: TD Ameritrade

The second filter that we use is the weekly price momentum or the VC weekly price momentum indicator (PMI). Coming into this week, the VC weekly PMI gave us a price of 2480. The artificial intelligence told us that since the market closed below 2480 at 2414, the sentiment of the market was bearish coming into this week. This analysis confirmed the first filter, which was the trend momentum, and now we are getting confirmation of the second filter, which is the price momentum, where it's a 50/50 standard deviation that identifies for us the momentum of the market.

However, it's clearly stated that even though we came into this week with a bearish trend momentum, it identifies where to cover your positions with the highest probability factor. The VC PMI gives us two levels below the mean. The first is the buy 1 (B1) level, which is at 2343 and the second is the buy 2 (B2) level, which is at 2272.

So when you as a self-directed individual have access to this information a day, a week or a month ahead of time, you can create your own structure in your portfolio in stocks, commodity options or futures. The report told you that if the market comes down from 2414 be prepared to buy at the B1 level of 2342, which has a 90% probability factor that the market will revert back to the average price of 2480. The second level or B2 has a 95% probability of that reversion to occur and in this case, it told us that the B2 level coming into this week is at 2271.

As we came into this week, the low that we made in the market was 2316.75, which was made on December 25. Unfortunately, the US markets were closed on Christmas day and this is what happens sometimes in the Globex markets when the players take advantage of the US markets being closed and they trade the Globex markets. You can see in the action in the market that the B1 level of 2343 has been activated a couple of times.

On December 26, the market at about 12 am in the Globex session gave us a clear breakout point, with the market closing above the B1 level of 2343. It also closed above the 9-day moving average, which is a very strong signal that essentially met the target of 2480 as of December 26 at 9:15 am.

When the market meets its target and completes the pattern, the VC PMI algorithm signal reverts back to neutral. In this case, the signal went long from 2343 with the target of 2480 (+37 ticks profit) in the weekly report, which we also call the swing report. We are back to neutral, waiting for the price to dictate the next trade. A close above 2480 would activate the bullish trend momentum of the market once again and activate a sell 1 (S1) target of 2550 and sell 2 (S2) of 2687. The extreme below the mean of 2480 is at the B1 level of 2343, while B2 is at 2272. With the market trading below the average price we are in a neutral to bearish sentiment and we are looking for the next trigger point in the weekly reports.

Please be aware that what we are talking about here is a contrarian system, which is called mean reversion trading. When the market is the most bullish, the system recommends going short and for sellers to take profits. When the market is the most bearish, such as just before the anticipated Christmas rally, the VC PMI recommended buying, which is what I told my subscribers. Please remember that this is a contrarian strategy, which goes against the general sentiment out there, and is something to be aware of when you apply the VC PMI.

The VC PMI Automated Algorithm

We use the proprietary Variable Changing Price Momentum Indicator (VC PMI) to analyze the precious metals markets. The primary driver of the VC PMI is the principle of reversion to the mean ("Mean Reversion Models of Financial Markets"; "The Power of Mean Reversion in Factor-Based Investing"), which is combined with a range of analytical tools, including fundamental logic, wave counts, Fibonacci ratios, Gann principles, supply and demand levels, pivot points, moving averages, and momentum indicators. The science of Vedic Mathematics is used to combine these elements into a comprehensive, accurate, and highly predictive trading system.

Mean-reversion trading seeks to capitalize on extreme changes in the price of a particular security or commodity, based on the assumption that it will revert to its previous state. This theory can be applied to both buying and selling, as it allows a trader to profit on unexpected upswings and buy low when an abnormal low occurs. By identifying the average price (the mean) or price equilibrium based on yesterday's supply and demand factors, we can extrapolate the extreme above this average price and the extreme below it. When prices trade at these extreme levels, it is between 90% and 95% probable that prices will revert back to the mean by the end of the trading session. I used this system to analyze the gold and silver markets.

Strengths and Weaknesses

The main strength of the VC PMI is the ability to identify a specific structure with price levels traders can execute with a high degree of accuracy. The program is flexible enough to adjust to market volatility and alerts you when such changes take place, so one can adjust strategies accordingly. Such changes include when the market breaks out of a consolidation phase or a trend accelerates. Such volatility usually happens when the market has produced a signal at the S2 or B2 level, and the market closes above or below these extreme levels. The day trading program then confirms that a higher fractal in price has been identified and the market will move significantly higher, although the same principle applies if the market falls significantly. By the price closing above the S2 level, it indicates that the buying demand is greater than the supply. This means that the market has found support for the next price fractal. Conversely, the price closing below the B2 level indicates that the selling pressure has met demand greater than supply at the extreme below the mean, and prices should revert back to the mean.

The basic concept of the VC PMI is that the program trades the extremes of supply and demand based on the average price daily, weekly, and monthly.

The strongest relationship we find in the algorithm is when the daily price is harmonically in alignment with the weekly and monthly indicators. We call this "harmonic timing." Such an indication produces the highest probability (90%) that the price will revert from these levels to its daily, weekly, or monthly average.

Disclaimer

The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed herein constitutes a solicitation of the purchase or sale of any futures or options contracts. It is for educational purposes only.

Disclosure: I am/we are long SPXL. Business relationship disclosure: I am the Director of Research for the Equity Management Academy and wrote this article for the Academy.