'Inside Secrets of Investing' Blog

•  Little-Known Indicators and Techniques  •  Actionable  •  Effective  •  Evidence-Based  •  Unique


(Before It Occurs)


Extremely overextended prices characterized the week ending January 26 and conditions were set up for a sharp downward correction. We can quickly determine this fact by using a couple of twists to common charting techniques. When stock prices meet these conditions, it is a red, flashing-warning signal of an imminent, rapid decline, which investors can then sidestep.

The 50-week (one-year) moving average serves as a pivotal long-term average (or long-term mean) of the market. When conditions become too far extended above that long-term mean, it signals that stocks are ripe for a sharp correction or, as it's sometimes referred to by professionals, reversion-to-the-mean – and that's precisely what occurred.

Chart 1 below shows a weekly price chart of the S&P 500 in the top window. In the lower pane, the Percentage Price Oscillator (PPO), a measure of the percentage movement of prices, is set so that it shows the percentage that the S&P 500 is stretched each week above its 50-week exponential moving average (EMA), a moving average that serves as the market's long-term mean. We can see that the S&P 500 reached a level of 14.2% above this long-term mean during the week of January 26. It has been seven years (January 2011) since the S&P 500 previously extended that far above its long-term, 50-week mean, which is noteworthy.

Chart 1:  The week of January 26 saw prices move 14.75% above the long-term mean (50-week moving average), setting up the market for a sharp correction.

Whenever prices stretch too far, too fast above their long-term, 50-week mean, or above their intermediate-term 20-week mean, it is always a prelude to a reversion back to that mean. The force of investor greed regularly pushes prices too high during periods of overexuberance, which occurred in January following the corporate tax reform measure that Pres. Trump signed in December.

Then, as institutional investors began to take profits at that high and prices started to decline, fear took over, and millions of investors pulled the trigger to sell more shares, resulting in prices tumbling back down towards their long-term mean.



Another charting tool that offered investors a warning of the imminent selloff in late January is Bollinger Bands. Created by John Bollinger, these are volatility bands placed above and below a moving average. We measure volatility by standard deviation, which changes as volatility increases and decreases. The bands automatically widen when volatility increases and narrow when volatility decreases.

While most traders apply Bollinger bands to daily stock charts, we use weekly stock prices with the Bollinger bands set at two standard deviations from a 20-week moving average. We consider the 20-week moving average to be the intermediate-term mean of stock prices. Bollinger Bands set to two-standard deviations from their 20-week moving average (mean) should contain about 96%-98% of all closing weekly stock prices. When prices move above the bands, it means they have gone too far, too fast and there is a significant likelihood of reversion back to the mean (and possibly even further). The same principle applies if prices close below the lower Bollinger Band; it signifies deeply oversold prices and can trigger a 'buying panic' that results in a sharp jump in prices.

Chart 2 below shows that prices had closed slightly above the Bollinger Bands the week of January 8 and week of January 16. This was pushing the limit, but then the week of January 22 saw the S&P 500 ETF (SPY) price close significantly (more than 1%) above the upper Bollinger Band. The following week the inevitable occurred, as prices of the ETF plummeted -3.88%. This move was unusual because there had not been a weekly move of more than 1% throughout all of 2017 and into the first two months of 2018 - 14 months of very low volatility. 

Chart 2:  The week of January 26 saw prices move 14.75% above the long-term mean (50-week moving average), setting up the market for a sharp correction.

Last week (February 4-9) saw even more significant selling, as prices dropped another -5.06%.  While overshooting below the 20-week moving average, this may have been merely a case of reactionary overselling. On the other hand, it could mean that this is a more significant, long-term correction that will see prices revert to their long-term, 50-week moving average, rather than the 20-week EMA. In the coming weeks, if prices return higher, it will show that the recent extreme price change was just a technical, reversion-to-the-mean move and the rally should resume.

The bottom line from a review of the above charts is that in a frenzy over the December tax cuts, the market went into a near-parabolic pattern during January. After reaching extremely overextended levels the week ending January 26, the market performed a classic reversion-to-the-mean and returned to its essential, 20-week moving average (an maybe lower, to its 50-week moving average).

By being aware of overextended conditions that technical indicators showed was occurring in late January, investors can prepare for the inevitable, attention-grabbing, fear-inducing, reversion-to-the-mean correction moves. Unlike tha vast majority of investors who can become panic-stricken you will be able to shrug your shoulders, knowing it is nothing more than a price realignment. Remember, as long as the underlying, fundamental conditions remain intact (as they seem to be for now), corrections are merely temporary, technical price adjustments and have little long-term significance.


Not Yet an ETFOptimize Strategy Subscriber?

Get a Complimentary Strategy Subscription
including proprietary Market Analysis - FREE!

For many decades individual investors have been poorly served by the investment industry, which has primarily relied on the discretionary selection of individual stocks, based on 'expert' opinions, as their investment vehicle of choice. Shockingly, according to Dalbar, Inc., since 1994, individual investors have recorded a rolling 10-year average annual return of only 2.6% per year – slightly higher than the average rate of inflation (2.4%). It's a sad, but accurate fact that speaks to the failure of investment advisors to predict the future, which has been the industry-wide, ubiquitous business model for many decades.

For a growing number of investors who recognize these facts, the solution is to eschew the fees and failures of professional stock pickers and instead to take the advice of investment legends such as Warren Buffett. The wealthiest investor in the world, Buffett recommends that savers should merely put a percentage of every paycheck in a low-cost, index-based fund, such as an Exchange Traded Fund (ETF), then hold that investment through thick and thin until retirement. However, these investors eventually face the stark realization that a buy-and-hold of an index ETF – through all market cycles – will regularly entail losing half or more of their entire savings when an inevitable bear market occurs, as happened most recently in both 2000-2003 and 2008-2009.

These recession-related bear markets come with the intense stress of seeing half or more of your hard-earned life-savings evaporate, and those losses take many years from which to recover. After the 2008-2009 stock market crash, it required more than five years for stocks to recoup those losses and get back to breakeven. Also, many investors have in the back of their minds a potential repeat of the devastating 1929 crash, when stocks lost -90% of their value and set off the Great Depression.

The solution? A quantitative, ETF-based investment strategy that gets you out of the market before these devastating downturns can eat half your savings. The ETFOptimize.com quantitative investment strategies have a proven track record of consistent, high-performance success since 1998, with a primary objective of eliminating those devastating losses. Tossing aside predictions of the future income of individual companies, our strategies rely on macroeconomic, market internals, stock fundamentals, and technical indicators to select the ETF that is optimum at any given time. The models respond to events as they unfold, rather than attempting to predict the direction of the market or individual stocks.

Providing an average annual return of 26.79% – and 30.53% for our Premium strategies since their inception – our model's performance amounts to more than quadruple (415%) the long-term annual return of the S&P 500, and more than eight times more than the performance of the S&P 500 since 2000. Moreover, the ETFOptimize premium investment strategies have collectively outperformed the S&P 500 in 63 of 66 years (95.5%) since inception!

Our strategies use proprietary, quantitative algorithms run on a financial-analysis platform that has been continuously upgraded and refined over the last 15 years. The platform relies upon high-quality, point-in-time financial and economic databases supplied by S&P Global Market Intelligence's Compustat and CapitalIQ. We've also adapted our strategies to embrace the enormously popular Exchange Traded Funds (ETFs), allowing investors to hold just a few positions while still attaining robust diversification across hundreds or even thousands of individual stocks, thereby eliminating the individual-company risk of a bankruptcy or other disastrous event.

Why not look over our strategy lineup now and see if there is one that is a good fit for you? It's surprisingly affordable to put a consistently profitable, high-performance investment strategy to work for you. The ETFOptimize Premium models are available by subscription starting at just $14/mo, or you can register for a 90-day subscription to our free, S&P 500 Conservative Strategy to see if systematic investing is appropriate for your needs.


If you aren't sure that quantitative investment strategies are right for you, we know of no better way to help you decide than to give you a sample of our product. Now you can register for a complimentary, sample strategy for three full months to help you decide whether to subscribe to one of our higher-performance, Premium strategies. This limited offer is no BS, 100% free – no credit card is required to register for the sample, S&P 500 Conservative (1 ETF) Strategy.

Just like our Premium (paid) strategy subscribers, you'll get weekly performance updates, trade notification (which occur only about 2-3 times per year), and a weekly synopsis of what's taking place in the market and why. Plus, all our subscribers get an exclusive first-look at timely articles that analyze our proprietary indicators and their implication for the market, with clear explanations of how the strategies are dealing with current and near-term conditions. Written for investors who prefer their content in plain English, these articles omit the plethora of industry buzzwords and high-level math concepts that often accompanies our competitor's publications.

You get all this valuable content just by registering for your complimentary strategy today. No credit card is required, and you have no obligation whatsoever. Visit our ETF Investment Strategy Suite now to select the quantitative strategy that's perfect for you!

Visit our  ETF Investment Strategy Suite



Site Features

Discover the secrets of successful investing