“Be like water making its way through cracks. Do not be assertive, but adjust to the object, and you shall find a way around or through it. If nothing within you stays rigid, outward things will disclose themselves.
Empty your mind, be formless. Shapeless, like water. If you put water into a cup, it becomes the cup. You put water into a bottle and it becomes the bottle. You put it in a teapot, it becomes the teapot. Now, water can flow or it can crash. Be water, my friend.”
―Bruce Lee
A key to my portfolio management approach is flexibility. The market environment changes and a rigid approach leads to suboptimal performance. An edge is created and exploited by remaining nimble. Daily, I focus on determining the state of the current market environment and identifying changes in the environment. When a new environment develops, I adjust.
I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.
- Jimmy Dean
When I make a trade, take on a new position or manage a current one I want to do so with the odds in my favor. I like to think of this as sailing with the wind at my back. If the market wind is blowing south, I do not want to be traveling north. I trade with the trend. Assessing the overall market environment allows me to know which way the wind is blowing.
My main work for assessing the Market Signal is performed on the SP500 (SPX).
The Market Signal takes into account multiple time frames
Short term (days - weeks)
Intermediate term (weeks - months)
Generated from the input of 3 models.
The Market Signal Guidance System
Overheating Model (Overbought)
Oversold / Trigger Model (Accumulation / Overly Bearish)
11 Market Environments
There are 11 potential Market Environments
Red Chop: –
No definable trend
Or Sideways trend that has “Whip” like action with above average volatility
Red Bear Market–
20%+ off the high of the previous Bull Market
Price below 200D SMA
Intermediate Trend: Downtrend
Alpha Signals: Not Bullish
ERModel: < 0
Red Correction
8%/10% - 20% off the high of the previous Bull Market
Intermediate: Downtrend
Alpha Signals: Not Bullish
ERModel < 0
Red Bull Heavy Pullback
4% - 8%/10% off the high of previous Bull Market
Intermediate: Uptrend
Alpha Signals: Not Bullish
ERModel < 0
Red Bear / Correction Market Rally Attempt
The Market has moved off the bottom
An Oversold / Trigger Signal has Triggered
Intermediate: Downtrend
Alpha Signals: Not Bullish
ERModel < 0
Yellow Bear / Correction Rally
Intermediate was in a downtrend
An Oversold / Trigger Signal has Triggered
Alpha Signals: Not Bullish
ERModel > 0 and < 9
Yellow Bull Pullback
3% - 4% off the high of previous Bull Market
Intermediate Trend: Uptrend
Alpha Signals: Not Bullish
ERModel > 0 and < 9
Yellow Bull Market / Heavy Pullback → Turn Up or Bull Caution
Intermediate Trend: Uptrend
Alpha Signals: Not Bullish
ERModel > 0 and < 9
Green Bull Level 1
Intermediate Trend: Uptrend
Alpha Signals: Bullish Level 1
ERModel > 8
Green Bull Level 2
Intermediate Trend: Uptrend
Alpha Signals: Bullish Level 2
ERModel > 8
Green Strong Bull Level 3
Intermediate Trend: Uptrend
Alpha Signals: Bullish Level 3
ERModel > 8
The Market Cycle Model
The Market Signal is broken down into 11 Environments which fall into 3 groupings: Red, Yellow, and Green. The Market Cycle Model helps determine which gropings the current conditions warrant. The Model is comprised of 3 Sub Models which work together. The Sub Models are:
Intermediate Model
ERModel
Alpha Signals Model
Link
Overheating Model (Overbought)
Used in strong markets (Bull Level 1 or higher) where the Environment becomes Overbought. Used to signal that some defense may be warranted for the inevitable pullback.
Link
Oversold / Trigger Model (Accumulation / Overly Bearish)
It’s easy to get negative during a correction or a bear market. The market will give explicit signals when the environment is changing from bearish to bullish. The Oversold / Trigger model provides criteria to force exposure when these signals occur.
Link
Conclusion
Utilizing these Models provides me with guidance on how much exposure to take on during different environments. The Market Cycle market allows me to allocate funds in the direction of the wind. The Overheating Model keeps the exposure from getting overly bullish when a natural pullback might occur. The Oversold / Trigger Model keeps the portfolio from being too bearish or defensive when a bottom or accumulation is apparent. The mixture of these models keeps the allocation flexible and nimble for an ever changing environment.
Notice: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. The information has been obtained from sources I believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. Authors may own the stocks they discuss. The information and content are subject to change without notice.