Investing Performance:

Call the Bottom

13 October 2018

Improving investor performance is largely about establishing policies and procedures as part of a larger process. Whether mutual funds, ETFs, stocks, bonds, futures or commodities, defining the process is paramount to improved performance. Without that there can be no effective after-action review, no possibility of learning and therefore only some random chance of performance improvement.

Our aspiration is to deliver 10alpha: planning, discipline and review of our decision-making makes that a possibility.

Inevitably, our internal biases affect our decision-making. Being aware of those biases and their negative impact on rational decision-making is critical to performance improvement.

A significant challenge is to preclude all the talking heads on the tube from unduly influencing your decision making. Remember, investment houses only make money on what they have put into the market for their clients. If you think being in cash is better at any given time, any and all of them will try to convince you otherwise. Whether they want you to 'stay the course' or 'move to defensive', they only make their money if you are invested.

These people are not your friend. While they can help you achieve your goals, you must understand their motivation and take an active role in protecting your own interests. After all, nobody else will do that. But all of them play on your biases rather your rational side. It may be the Availability Bias (what you hear most recently most often); Bandwagon Fallacy (everybody is doing it); or the Gambler's Fallacy (I've been wrong for so long I've got to be right tonight).

Remember that stocks know nothing about technical indicators. The only place where the 200 day moving average, advance decline lines, relative strength indicators, etc., matter is in the backroom "quant" shops where doors are closed and raw meat fed under the door to keep them happy. Or, the algorithm compute intensive shops. No matter what technical indicator you care to use, it is a human construct, not one that is a physical law of nature.

That does not mean it is unimportant; quite the contrary. Any and all of these indicators attempt to improve the probability of a successful investment in some vehicle. The more widely held the belief in an indicator, the more likely it will become a self-fulfilling prophecy. They are detrimental only to the extent your adviser uses them to counter your own rational thinking.

In our self-talk we must separate the personification of stocks from the reality. It is quite like believing in magic versus recognizing there is some rational explanation for the event. Failure to do so will always leave you making irrational decisions based on faulty logic supported by talking heads whose main goal is to keep you invested.

Let's run through some ideas on selecting entry points, something that is particularly timely given the market pullback. At the end, we'll tell you the secret for calling the bottom for any stock, sector or the market in general, something none of your advisers are likely to share with you.

As with all that we do, we use a procedure to identify high probability entry points. It is not difficult and we'll share a few of the elements here.

Bottom Fishing

Check your Strategic Perspective

Before anything else, we need to check our strategic view. If that has changed materially in some way, it can change the course of our evaluation.

For us, little has changed although there are increasing impacts from tariffs, geopolitical tensions and the upcoming mid-term elections. All in, our view remains at targeting 3000 on the S&P 500 by year end. We've been expecting and preparing for a significant correction, so this is no real surprise.

Your view may differ and you must honor your view. That is what makes a market.

What would change our view? War, impeachment (of any of several potential candidates in the continuing Keystone Kops Washington circus) or President Trump giving in to backing off on tariffs.

Do some analysis

We will look at the monthly, weekly and daily charts for SPX. Our goal is to identify 'levels', value points on the chart where there was resistance. We really want 'strong levels' meaning that the price bounced off of it more than once. The more times, the stronger it is. This is not a case of more is better. We really want levels with true meaning to the 'quants' out there that swing billions of dollars.

Monthly chart

On the 20 year monthly chart, there are not many really strong levels. It looks like 2100 and 1560 at least have more than one reversal showing. You could also pick the 1930. We didn't only because bigger round numbers attract people more. The 2100 level will be much stronger support than 1930 simply because it is at a 100 level versus a 10 level.

One thing we teach in our TAP training is to use a fat pencil on levels. Being accurate to the second decimal place on an estimate is a mind trick. We teach how to use the Ichimoku clouds (the yellow and red shaded parts) to your advantage as well.


Weekly chart

We next look at the 20 year weekly. With the same process, we look for levels that are hit multiple times. You may have to zoom in to 2 year sections to see these well enough on the chart.

Not surprisingly, there are weekly levels at the monthly levels. There are also some additional levels identified in between. Again, we highlight the stronger levels with heavier lines.


Daily chart

Now we look to the 20 year daily chart for more levels.


Levels Analysis

Well, now we have quite a mess of a chart. We zoomed in to a 2 year timeframe and chose the strongest of the levels as our Key Levels. We added the Fibonacci Retracement for the next part of the discussion.

SPX Daily Chart
Fibonacci Retracement

Some observations and more data:
  • 2200 is very strong; 25% correction
  • 2600 is pretty strong; 12% correction
  • 2700 is very strong; 8% correction

Historically, a 15% correction is an average correction. We'll set 2600 as our current target bottom. Our intent is to attempt to outplay the players by forseeing where the big money may come back in based on a bunch of technical indicators, fundamental data, geopolitical data, earning, etc. It is by no means an answer. It does indicate more downside is possible.

To be clear, there is no right or wrong answer. Equally important, every person will find these levels in somewhat different places on the chart. All of that is ok.

Fibonacci, Elliott Wave, Moving Averages

Let's come at it from a different direction.

At the daily resolution you could make the case for a Fibonacci Elliott Wave pattern starting about February of 2016. Looking at Fibonacci Retracement, the SPX has broken down through the 38.2% level with authority. The 61.8% level coincides with our 2700 key level and is the 'golden mean' level which gives it heavier weighing with the quants.

The light blue moving average curve on the chart is the 200 day moving average. The 200 day tends to be strong support for the quants. The SPX broke that, then recovered. That could bode well for next week.

Should we break through the 61.8% Fibonacci level our 2600 level looks very possible.


No bottom yet. We need to continue to watch and wait patiently. If you cannot be patient, only add 1/8th size positions only where you have some very strong beliefs in both the sector and the stock. Using options, go out 6 months or more depending on your preferences.

Until the big money boys decide to lift the market, hanging tight is a reasonable plan.

This process can be used for equities topping out as well while looking for bearish entry points.

Any sufficiently advanced technology is indistinguishable from magic - Arthur C. Clark