The stock market’s medium term is decisively bullish, while the short term is a 50-50 bet. Focus on risk reward and focus on the medium-long term.
The U.S. stock market crashed even more today.
*This is written after the market close on Wednesday, October 24, 2018
Needless to say, many traders are probably shocked by the size of today’s decline. In a sea of “the world is ending!!!!” headlines, I would like to reiterate my main point from yesterday.
The stock market’s medium term risk:reward is bullish.
The short term outlook is no longer bearish. It is now a 50-50 bet. The stock market might fall a little more in the short term, or the bottom could already be in. Either way, trying to predict the exact bottom is a meaningless game. Nobody can consistently and accurately pick the exact bottom. Otherwise you would be a god.
When the market’s short term outlook is no better than a 50-50 bet, focus on the medium term.
Moreover, focus on the facts and ignore the sensationalized headlines.
The Medium Term is bullish
*Let’s analyze the stock market’s price action by quantifying technical analysis. For the sake of reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.
2 crashes in a row
This stock market crash has been exceptional in that the S&P saw two greater than -3% declines in a span of just 11 days.
Such crashes are rare. They tend to happen at the bottom of a “big correction” (as defined by our Medium-Long Term Model). Even during a bear market, when the stock market has already crashed 30%+, this often leads to a medium term rally.
Here’s what happens next to the S&P 500 (historically) when it falls more than -3% in at least 2 of the past 11 days.
Bear markets don’t start with high velocity
The stock market has fallen 9.8% from its September 2018 high – present.
The S&P has gone down 6 days in a row, with the final day falling more than -3%.
Such “capitulation selloffs” are very rare. 1950 – present, this has only happened 3 other times.
While this doesn’t mean that we’re at the bottom of a bear market (e.g. February 2009), it certainly means that if you sell now, you are close to selling at the bottom.
As you can see, the above study has a very small sample size. Let’s relax the parameters. Here’s what happens next to the S&P 500 when it falls 6 days in a row, and then falls more than -2% on the final day.
None of these cases marked the start of a bear market.
The short term is a 50-50 bet
Picking the exact bottom of a “small correction” is always hard, which is why the short term is generally a 50-50 bet. That is also why we usually avoid the short term.
The S&P has fallen in 13 of the past 15 trading days.
When this happens (historically), the short term is close to a 50-50 bet (with a slight bearish lean).
Meanwhile, the S&P is now more than 7% below its 50 day moving average.
While some traders see this as a potential for “mean reversion”, it actually has a slight bearish lean.
When the S&P is -7% below its 50 dma, its returns over the next month are slightly bearish.
Here is our discretionary outlook based on these market studies:
The medium term remains bullish (i.e. trend for the next 6-9 months). The speed of this selloff has hit an extreme. When this happens, the stock market may or may not go down more in the short term, but the medium term is decisively bullish.
When the stock market’s short term is unclear (as it is most of the time), focus on the medium term. Step back and look at the big picture. Don’t lose yourself in a sea of noise.
Our discretionary outlook is usually, but not always, a reflection of how we’re trading the markets right now. We trade based on our clear, quantitative trading models, such as the Medium-Long Term Model.