MDM - Why did the model switch to a sell signal today? [June 22, 2011]

Published : June 22 2011 at 20:49 ET
The model is rules based. The action of leading stocks, the weak bounce, and the technical action of the market after Bernanke's press conference all acted to push the model into a sell signal. The general market and leading stocks starting to accelerate their descent after Bernanke's press conference.

In this age of quantitative easing (QE) which has fueled the markets higher since March 2009, the fed's actions regarding QE are important to monitor. That said, it is not what the fed says they are going to do or not do, and it is not lower projected growth estimates or any other piece of bad news, but rather how the market reacts to such news. The market's reaction after Bernanke's press conference where he held out no hope as of yet for a QE3, was quite negative with poor action among leading stocks and major averages, thus pushed the model into a sell signal.

The buy signal on June 21, then the sell signal on June 22, is rare, but part of the model's success is its ability to turn on a dime if necessary. In the rare instances when the model switches signals rapidly, it has two benefits: 1) the ability to catch the start of a trend, and 2) the losses from the prior signal are either minimal or zero.


Incidentally, June 1, 2011 was not a sell signal because QE2 was still in effect, thus the model kept its neutral stance. It had done this with success after its sell signal on April 28, 2010 by staying neutral longer than normal between late May and early August, and thus avoiding being whipsawed in a highly volatile and trendless market, as it issued only two signals: one which was breakeven, and the other which was a loss of -1.5% using the NASDAQ Composite as benchmark.

That said, the NASDAQ Composite fell -9.95% from peak-to-trough since June 1, 2011 and it did so on news that was not nearly as bad as the news in February and March 2011 when the NASDAQ Composite fell -8.3% peak-to-trough. This showed that the markets were expecting quantitative easing to end or to have a limited impact on propping the markets going forward which represented a material change in the market's perception of quantitative easing. Thus, the rules that kept the model neutral for a longer period have recently been suspended until there is indication of a QE3 as shown by Bernanke's words together with price/volume action in the general market. Again, it is not the news itself or Bernanke's words that matter but how the market reacts to the news by way of price/volume action of the major averages and leading stocks.

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