Based on the title containing "only six other times", you may have questions about small sample sizes; that topic is addressed in detail later in this article.
Weight Of The Evidence
The weight of the evidence in a court of law can refer to:
The whole set of evidence presented on a topic or question, such that the overall weight of the evidence can be said to favor one conclusion or the other.
Momentum From A Different Perspective
In the financial markets, we can always find bullish evidence and we can always find bearish evidence. The weight of the evidence is ultimately what helps form the market's net aggregate opinion about the value of any asset. If we have ten pieces of bullish evidence, that is better than one piece of bullish evidence.
We recently presented a long-term set-up (or signal) using the S&P 500's Coppock Curve. Is there any other evidence that aligns with the Coppock Curve analysis? Yes, another method of monitoring bullish and bearish momentum in the stock market recently completed a rare sequence of events.
Rate Of Change: A Very Rare Occurrence
In 2015, the S&P 500's weekly chart printed something that has only occurred six other times since 1983. The analysis below is an extension of the "rare readings and key reversal" data that was presented on October 2 and October 9. The two rare October events, described in video clips (key reversal, CCI exits oversold) said "be open to a bottom and rally in stocks".
The Rate of Change indicator does exactly what you would expect it to do; it measures the rate of change from one period to the next. Similar to the Coppock Curve, it helps us track bullish and bearish momentum. The chart below shows the rare and extreme set-up that recently occurred in 2015.
This Is A Long-Term Set-Up
The Rate of Change set-up is a long-term set-up, which cannot be emphasized enough. Like the Coppock Curve analysis, this Rate of Change analysis is looking out roughly 10 weeks to 3 years, rather than hours or days.
Before we move to the "what happened in the stock market historically" segment, it is important to define what this study covers:
- Weekly S&P 500 Rate of Change (ROC).
- ROC must drop below -8.25% as it did in 2015.
- ROC must recapture the zero line as it did in 2015.
- ROC must recapture 5% as it did in 2015
- Examples in a bull market (in 2015 the S&P, for now, remains in a bull market).
How Rare Is This Set-Up?
After the secular bull market was established in 1982, the S&P 500's weekly Rate of Change did not drop below -8.25% until 1987. Rate of Change dropped below -8.25% three other times (1990, 1998, and 1999) before the bull market ended in 2000. Therefore, the total number of set-ups in the 1982-2000 bull market came to 4 (see below).
The set-up we are studying involves such an extremely low and rare level of momentum that not one set-up occurred between 2003 and 2007 that fully meets our criteria. Under our approach we would have classified the market's profile in early 2003 as "bear market rally/new bull market attempt" rather than "an established bull market". Therefore, the 2003 example shown below near point A falls outside the scope of this analysis. It should be noted after hitting a rare and extreme level in 2003, Rate of Change was still helpful.
Since the S&P 500 flipped back to a bull market profile in March 2009, weekly Rate of Change has only dropped below -8.25% on two other occasions (2010 and 2011). Therefore the total number of set-ups that occurred in the 1982-2000, 2002-2007, and 2009-2015 bull markets is 7, with 2015 being the 7th occurrence.
Why Only Study Examples In A Bull Market?
In calendar year 2015, the S&P 500 remains in a bull market until proven otherwise. As of December 1, 2015, the S&P has not dropped 20%, nor is it trading below its 50-day and 200-day moving averages, meaning the plunge in August looks like a correction in the context of an ongoing bull market. Therefore, if the S&P 500 is currently in a bull market, then it is logical to study similar S&P 500 weekly Rate of Change examples that occurred in an established bull market. More detail on the bear market topic follows the historical charts below.
How Did Stocks Perform After The Set-Up (1982-2015)
In 1987, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 1987, the S&P 500 gained 40%. Similar to the November 27 rare and extreme Coppock Curve analysis, the Rate of Change set-ups presented here are longer-term signals, looking out weeks, months, and in some cases years. Notice after the signal in 1987 below stocks dropped for several weeks before the rally resumed.
In 1990, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 1990, the S&P 500 gained 42%. After the 1990 set-up, did stocks go straight up? No, stocks dropped, then rallied.
In 1998, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 1998, the S&P 500 gained 32%.
In 1999, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 1999, the S&P 500 gained 14%.
In 2010, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 2010, the S&P 500 gained 21%.
In 2011, the S&P 500's weekly Rate of Change dropped below -8.25% and then recaptured both the 0 line and 5%, which is similar to what just happened in 2015. After the rare set-up in 2011, the S&P 500 gained 15%. Keep in mind, the set-up in 2015 is a long-term set-up. In 2011, after the set-up stocks dropped significantly before resuming the bullish rally.
What About Bear Markets?
In a bull market, our bias is to own stocks, which is not the case in a bear market. We would expect Rate of Change to be weak in a bear market. A similar set-up occurred two times in 2001. In the chart below, notice how weak the hard data and hard evidence is when the Rate of Change set-ups occur. The negative slopes on the colored moving averages tell us the stock market was clearly in an established and ongoing bearish trend, something that can be captured via hard data.
How Does 2015 Compare To 2001?
If we use the exact same moving averages as those in the 2001 chart above, we see the observable evidence and hard data is more favorable in 2015 relative to 2001 (compare the 2001 chart above to the 2015 chart below). Said another way, the hard data in December 2015 is significantly better on numerous fronts relative to 2001. The previous statement is subject to change, which is why it is important to keep an open mind about all outcomes, even the 2015-2016 bear market scenario.
How About 2008?
A Rate of Change set-up did occur in 2008, but the observable evidence and hard data were pointing to an established and ongoing downtrend. For example, notice how the slope of the S&P 500's 50-week moving average is clearly down when the Rate of Change set-up occurs. The 50-week is one of many bearish examples of hard evidence that were present in April 2008.
How Does 2015 Compare To 2008?
Rather than a bearish slope, the S&P 500's 50-week moving average in 2015 is currently trying to turn back up in a bullish manner. Price has also closed above the 50-week and is currently above the 50-week. Compare the 2008 chart above to the 2015 chart below.
The 2015 chart above looks nothing like April 2008 when the Rate of Change set-up occurred (see 2008 chart below). In 2008, the S&P 500 never closed above it 50-week moving average and the slope of the 50-week never turned back up. Compare the 2008 chart below to the 2015 chart above. The 50-week is one of many examples of weak data that was present in April 2008.
But, Six Or Seven Occurrences Are Statistically Insignificant
Yes, that argument can be made about any rare occurrence in the stock market. We all learned in Statistics 101 that all things being equal we would prefer to study a larger sample of events rather than a smaller sample. While that is a general tenet of statistics, experienced traders and investors will tell you that some of the best stock market signals meet the criteria of "extreme and rare" occurrences. The list below shows a handful of occurrences where small sample size events (rare) can be very helpful in the financial markets:
- Rare and extreme sentiment readings
- Rare and extreme options activity
- Rare and extreme volume
- Rare and extreme breadth thrusts
- Rare and extreme 90% Up Days
- Rare and extreme 90% Down Days
- Rare and extreme intraday reversals
- Rare and extreme intraweek reversals
- Rare and extreme overbought readings
- Rare and extreme oversold readings
- Rare and extreme readings of Put/Call ratio
- Rare and extreme VIX readings
- Rare and extreme divergences
Bullish Rate of Change signals on the S&P 500's chart occur frequently, meaning they are not rare. The rare portion of this study is the combination of weekly Rate of Change dropping below -8.25%, within the context of an established bull market and recapturing both the zero line and 5%. Therefore, the study above fits into the rare and extreme category.
Small Sample Sizes In 2010 And 2011
We could have made the same "small sample size argument" in 2010 as well, but it would not have changed the S&P's 21% gain that followed the Rate of Change set-up; the same set-up that is present in 2015.
We could have made the same "small sample size argument" in 2011 as well, but it would not have changed the S&P's 15% gain that followed the Rate of Change set-up; the same set-up that is present in 2015.
Set-Ups Assist With Odds Of Success And Failure
The rare and extreme Rate of Change set-up in 2015 speaks to probabilities. The term probabilities implies that some set-ups "work" and others "do not work". Is it possible the S&P 500 morphs into a bear market in 2015-2016? Answer : "absolutely, positively yes, it is possible". We are dealing with probabilities.
Analysis Passes The Common Sense Test
Waterfall plunges in the stock market are relatively rare (1987, 2010, 2015), which means any data points associated with a waterfall plunge will also be rare. Notice that all of the rare and extreme Rate of Change examples above are followed by a sharp reversal and rally in stocks. Sharp drops are rare; extreme reversals are rare, and thus any analysis of waterfall declines followed by extreme oversold readings will involve a relatively small sample size.
Extreme Value Analysis In Statistics
Category 5 hurricanes are rare and extreme events that can be forecasted by detecting rare and extreme weather patterns or profiles. In the field of medicine, diagnoses are often made after finding rare and extreme conditions in the human body. Rare occurrences and rare data points have their own branch in statistics, known as extreme value analysis (EVA), which can be used in the study of extreme floods, large insurance losses, rogue waves, large wildfires, loads on structures, pipeline failures, and the financial markets.
Are You Using ROC To Forecast Outcomes In 2015-2016?
No, we make decisions based on the weight of the evidence. Rate of Change is part of the weight of the evidence tracked by our market model. The purpose of the exercise is simply to present the historical examples that are similar to the 2015 Rate of Change set-up. Under our approach, we will continue to make decisions based on the facts. Facts can change and probabilistic set-ups can fail. We will not alter our approach in any way as a result of the Rate of Change set-up. If bullish outcomes are in the cards, the hard data (including Rate of Change) will reflect that. If bearish outcomes are in the cards, the hard data will reflect that as well.