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Confusion Index Finds No Bear Market Around Corner at Trader’s Narrative





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The following is a guest post by Charles H. Dow Award winner, Wayne Whaley (CTA) of Witter & Lester. If you would like to receive his daily market email, send an email to waynewhaley [at] comcast [dot] net with the subject “ADD ME TO DAILY EMAIL”.

Unified Markets
When stocks are making unified surges in either direction, the market shows conviction and the historical tendency has been for equity prices to eventually work their way higher. Below shows the one year performance for the S&P 500 as a function of ADT (where ADT equals the five day sum of daily Advances divided by the sum of Advances plus Declines on the NYSE). Note that when ADT reaches a level above 70 (Thrust) or below 20 (Capitulation), the intermediate outcome for equities leans strongly toward above average returns - with the average annual return at 8%. Also note from this data table that ADT reached 76.53 on September 9th, 2009 and 20.47 as recently at May 20th, 2010:

FIVE DAY ADT vs. 1 YEAR S&P 500 PERFORMANCE
confusion index data Jun 2010

For the above table, data from 1970 to May 2009 was used to allow one year forward return calculation for the S&P 500 index.

Confused Markets
The opposite environment would be periods where stocks are displaying characteristics of confusion or loss of focus. I produced a table in Planes, Trains and Automobiles of a confusion index that was a function of both the number of stocks making new 12 month highs or new 12 month lows.

The concept was (similar to the ADT example above) that in bull markets, you should have either a lot of stocks making New Highs or a preponderance of stocks making New Lows, but not both. The Confusion Index was a moving average of the minimum of either the issues making New Highs or New Lows divided by the number of issues traded.

For example, if on any day, there were 3500 stocks trading and 70 made New Highs and 35 made New Lows, the one day confusion index would be calculated as follows:

One Day Confusion Index = Min(70,35) / 3500 = 35 / 3500 =1%

WCI smooths the above one day index with an exponential moving average of 0.05:

WCI (I) = 0.05 * [Min ( NH(I),NL(I) ) / Issues Traded] + 0.95 * WCI (I-1)

High readings (above 1.5) are bearish while low readings (below 0.5) are bullish. An WCI reading of 1% would indicate that we are in roughly a one month period where the NYSE is averaging at least 1% of issues trading at both New 12 Month Highs and New 12 Months Lows on a daily basis, a high number of stocks moving in opposite directions.

Since Planes Trains and Automobiles was written, I have made a minor modification to this index. I will be publishing more details on this soon, but the new index takes into consideration the range of the trailing 12 month market, as well as the number of issues making New Highs and Lows. Below shows the results of the new confusion index. The index has ranged from 0 to 2.4. As you can see, high readings tend to be bearish and vice versa.

ONE YEAR S&P 500 PERFORMANCE AS A FUNCTION OF WCI
confusion index data2 Jun 2010

For the above table, data from 1971 to May 2009 was used to allow one year forward return calculation for the S&P 500 index.

The current Confusion Index is currently (as of June 1st, 2010) at its 12 month high of 0.50. It would be very out of character for the market to go into bear mode without exhibiting more signs of confusion. For example, below is a list of major down turns in the market since 1970 and the level at which the Confusion Index (WCI) peaked in the preceding six months. As you can see, WCI reached at least 1.0 at some point in the six months preceding each of these down moves.

Bear Markets and Wayne’s Confusion Index

  • 2007 The market peaked on October 19th and a seventeen month, 56.8% decline followed. WCI peaked at 1.71 on July 23rd, 2007.
  • 2000 The market peaked on March 24th and a 49.14% decline followed. WCI peaked at 2.05 on January 3rd, 2000.
  • 1987 The market peaked on August 25th, 1987 and a very short but painful two month 33.24% decline followed. WCI reached 1.12 on August 8th, prior to the peak and actually reached 1.86 on October 6th, 1987 before Black Monday on October 19th 1987.
  • 1981-82 The market peaked on November 28th, 1980. A 19 month, 37.2% decline followed. WCI peaked at 1.94 on February 14th, 1980
  • 1976-77 The market peaked on Sept 21st, 1976 and a 7 month, 16.6% decline followed. WCI peaked at 1.11 on June 10th, 1976
  • 1973-74 The market peaked on Jan 11th, 1973 and a 21 month, 48.15% decline followed. WCI peaked at 1.57 on November 16th, 1972

The Confusion Index gave no indication that the recent 13% correction was in the cards and has missed some other 10% corrections as well, but it has an excellent record of calling bear markets and it would be very unusual - actually unprecedented - to go into a bear market without a +1.0% reading at some point in the six months prior to the downturn.

Stay tuned.

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8 Responses to “Confusion Index Finds No Bear Market Around Corner”  

  1. 1 Steve Howe

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    I am currently looking at 200ma above-below, nya200, and it is exhibiting the same behaviour as July 2007, topping and turning, the result was the top 3 months later, Oct 07, so I have been expecting a similar outcome this time. Your CI is something else to take into account, however. Stay tuned, I shall..Thanx

  2. 2 Babak

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    Thanks Wayne, great stuff. One thing I am curious to know is even though the market may be ahead 1 year forward, what was the worst drawdown during that time? This may give us an idea of the kind of correction that is “normal” during such cycles.

  3. 3 Pal

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    Interesting stuff. Thanks. From a simple minded person like myself I have a hard time seeing anything except a bear market. Don’t feel obligated to comment a I do read the other opinions.

    But I do have a question anyone can comment on.

    Assumption: You are either in a bear market or a bull market the timeframe of those descriptions is rarely mentioned in the same breath. If someone is supposing we are in a bull market I wouldlike them to provide what timeframe they are talking about.

    I personally believe we are in a bear market and unles new highs are set over a period time, let’s say sometime this year, “that aint no bull market” IMHO.

    Comments welcome.

  4. 4 Wes

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    Wayne,

    Excellent work. Has there ever been a reading or 1 or greater that was not followed by a bear market ? Even if there has, ” necessary but not sufficient ” is extremely valuable.

  5. 5 Wayne

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    Wes,

    A few comments on confusion index.

    Over the last 40 years, the S&P has been up 72% of years for an average of 8.0% a year. So although, I have been able to find a few systems that are 95% reliable over 6 to 12 months on the bullish side, it is much harder to find such systems on the bearish side. If anyone has a 90% reliable ‘intermediate” bear mkt system with 10 or more independent signals, please share. Bearish signals should probably be judged by how many times did they give below the 8% average performance, to put it on even playing field with bullish signals.

    The confusion index is help in identifying bearish conditions, but is not infallible. I consider 1.0 to be the warning level and 1.5 to be the level at which you could work into shorts with the odds on your side.

    To answer your question, wo doing any additional research, In Planes Trains and Automobiles, I produced a table (Table 8 on page 10) that showed the record of the seven shorts on WCI of 1.8 or higher, where rather than holding for a fixed time, you exited the short on the next thrust signal. The table won’t reproduce in proper format here, but they were 7-0 on the short side and you can refer to the paper. About 2 weeks ago, I produced a chart of the current PTA model’s performance, In that chart, all the shorts came from a combination of WCI and trend analysis.

    A side note of some interest. Since I get a lot of bullish signals from Breadth, Volume, and Price Thrust, I use WCI exclusively for bearish signals, but I very easily could use if for bullish signals as well. Below is a table of all WCI signals below 0.25, meaning the market is either in an environment where there are almost no new lows (thrust) or almost no new highs (capitulation). Not quite as powerful as a breadth or volume thrust signals, but notice a perfect 14-0 for the six month time frame. I hope this is legible. It should read Date, WCI, one month sp pctch, 3, 6, and 12 mt sp pctch.

    Date WCI 1mtsp 3mtsp 6mtsp 12mtsp
    710120 0.25 02.07 10.48 05.91 10.77
    720224 0.24 01.96 04.61 05.28 06.39
    741002 0.25 15.30 10.81 30.06 32.25
    750709 0.25 -8.70 -6.78 00.16 10.74
    760130 0.24 -0.83 00.77 02.56 01.16
    800616 0.25 03.05 09.17 12.50 13.83
    821028 0.25 00.46 08.17 21.98 22.29
    830603 0.24 01.33 02.11 00.81 -6.13
    871230 0.25 02.90 04.12 10.34 12.05
    910401 0.25 02.42 01.78 04.82 08.87
    030620 0.25 -1.70 02.72 09.76 13.51
    031223 0.25 04.15 -0.19 04.38 10.41
    090128 0.25 -19.82 -2.17 12.07 24.08
    090730 0.19 03.43 05.01 10.38 11.76
    NUMUP-NUMDN 10-4 11-3 14-0 13-1
    AVG S&P % CHG 0.43 3.62 9.36 12.28

    out of here

  6. 6 Tom

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    The confusion index appears to be similar the Fosback’s High-Low Logic Index. Fosback also uses the number of weekly new highs and new lows. He smooths it out by using a 10 week exponentional moving average. He considers over 5% average of MIN(NH,NL) over 10 weeks to be bearish. He also claims MIN(NH,NL) of over 10% measured on a 1 week basis to presage every major downturn. He cited 19 such weeks from 1950-1980. I have been keeping track of this weekly number since 6-9-07. For the week ending 7-18-07 the number was 8.3%(NH-542,NL295,issues-3559). For the week ending 10-31-07 the number was 9.25%(465-NH,332-NL,3588 issues). Close enough to be a prescient indicator.

    I have been trying to find if there have been any other times between 1980 and present that on a 1 week basis the percentage has been close to 10%. Finding weekly data is difficult. The best I could do was microfiche of the New York Times at a big city library. It was too tedious to pursue. Could anyone guide me as to where I could find that information?

  7. 7 Jim Kramer

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    Fosback invented this in 1979. It should not be presented as a new invention.

  8. 8 wayne

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    Eyon

    link for New highs and New lows on NYSE composite.

    Jim,

    If you read my paper PTA, I give Fosback the proper reference. I have made some modifications to his original work and take into consideration the range of the trailing 12 mts. I backed into the research from a little different angle, as I was researching ways to calculate anti thrust signals.

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