"The four most dangerous words in investing are 'this time it's different.'" — John Templeton
I continue my series answering your question: Were there signs or tools during previous market tops signaling it was time to lock in profits and move into safe haven investments?
Last week, I examined the 2000 market top and today analyze the market action in 2007-08. I use the same chart indicators focusing on just four items, the value of the SPX (Standard & Poor’s 500), my buy/sell signal line, money flow and a momentum indicator. There's no need to make it complicated.
Caveat emptor: Many analysts design charts, but then change indicators to prove their points. I am not in that camp and will use the same indicators in each analysis. If these indicators do not work, it will be apparent and I will identify as such.
For some, this is an introduction to charting and you may be saying the same thing that I did before I began — "What the heck is this?" All I ask is to follow along with the minimal goal of picking up one point per column. Stick with it. After a few columns, it will begin to make sense — and hopefully dollars and cents.
Since this is the first run at charting for many, let’s re-introduce the players. For price, I use the Elder Impulse System, developed by Dr. Alexander Elder. The value/price is represented by three colors: green, blue and red. They are called impulse bars. I read green bars as buying, blue as neutral, and red as selling.
Next, I monitor money flowing in and out of a security using the Chaikin Money Flow, developed by Marc Chaikin. I read green bars above zero as money moving in and red bars as money moving out.
Finally, always use an additional indicator for confirmation. In the bottom box, I feature the MACD Oscillator developed by Dr. Gerald Appel. I use it similar to the money flow, with bars above the zero line as money moving in and below the zero line as money moving out.
Per my chart, in July 2007, the SPX made a new high (point A) at 1555.90, while money flow was extremely positive and the MACD neutral. Profit taking hit in August 2007 (point B), but failed to signal a sell signal because price closed above the signal line, money flow remained positive even though the MACD was negative. Remember, all have to be negative to signal a formal sell signal.
Buying then came in and the SPX made a new high at 1576.09 in October (point C). In November 2007, the SPX broke through and closed under my blue signal line, the 50-period exponential moving average (point D). At the same time, the money flow was negative, along with the MACD. With all three hitting, this gave an official system sell signal.
After an sell signal, the SPX reversed (point E) and closed above my blue signal line, but did not formulate a formal buy signal because the pricing bar turned red showing selling and the confirmation indicator, the (MACD) remained negative.
You have free articles remaining.
In May 2008, SPX traded at 1440.24 above my blue signal line (point F) but the pricing bar remained red showing selling, the money flow went negative while the MACD turned positive. Once again, all must be positive for a formal buy signal to hit.
After the failed rally attempt, the SPX continued and eventually dropped 58% from the October 2007 (point C) high.
So here are the action points:
First, are you aware of the different tools available to signal market tops?
Second, are you tracking your holdings using these tool to see if they are topping?
Third, if not, why?
Wall Street makes money with clients being in the market no matter which direction the market or portfolios are going. Smart investors make money with what they own and when they own it. Which group are you in?
Eventually the current bull market will top and sell off — it cannot run forever. The problem? No one knows exactly when or even why. Plus, if we have an exogenous event, meaning something tragic from outside the market leading to large-scale prolonged panic selling, then you can throw this set-up out the window.
Next week, I will use these same indicators and system to see if it worked to signal the 2015 correction, to be prepared for when it happens again.