Trader’s Narrative

A few months ago I started to pay special attention to a remarkable but little followed technical indicator called the Coppock Curve or Guide. Peering ahead and assuming that the market would hold firm, I mentioned that by the end of May we would have a definitive buy signal. The market’s strength was impressive, as we all know and the signal did arrive for a new bull market.

Although of course, it remains to be proven beyond a shadow of a doubt that we have seen the low for this cycle, it looks to have been a valid signal. Returning to our hypothetical forward extrapolation of index levels, the Coppock Curve continues to act very bullish as it continues to rise out of the depths it had fallen to:

Source: InvesTech Research

If we assume that the S&P 500 index will close approximately where it is now by the end of August, then the Coppock Curve would continue to recover extremely fast, reaching -344. That is well above its February 2009 level and closing in on its January level.

That’s assuming that the market is unchanged until month’s end. But what if the market trips up from now until then?

In that scenario, the Coppock Curve still has a good chance of continuing to rise. In fact, the S&P 500 index would have to fall more than 200 points, below 780, for the Coppock Curve to stop climbing. That’s a hypothetical +20% decline.

And that is probably one of the positive consequences of this spring rally. Even if we were to give back 50% or even 65% of the advance, the market would still be able to carve out a higher low and a higher high - the very definition of an uptrend. Such a correction wouldn’t be surprising, especially when you consider the over confidence signaled by the various sentiment measures. But it would only wash out the weak hands and allow the market to continue higher.

While the track record of the Coppock Curve is impressive it is not perfect. If you squint hard enough, you’ll be able to make out the rare two times that its upturn did not mark a significant trend change.

But even so, since many are comparing this bear market to the one that came 80 years ago, it should be noted that the Coppock Guide was one of few technical indicators which allowed for the correct navigation of the bone crushing volatility of the 1929 bear market. During the aftermath there were several intense bear market rallies that fooled many. But they were all ignored by the Coppock Guide as it fell unrelentingly into the deepest level it has ever seen historically. Only in 1932 did it correctly give the all clear.

Continuing with the series, here is the fourth condition of a new bull market as outlined by Jim Stack of InvesTech:

I’ve hesitated to mention this technical indicator since I started writing this blog because it is almost too good. It is one of the few that have an uncanny ability to find the start of almost all major bull markets. So you can understand why I don’t want to run the risk of ruining it by popularizing it any more than it is. And it is not popular at all.

In fact, compared to say the RSI or MACD, the Coppock Guide is an esoteric and rarely mentioned technical indicator. It was created by Edwin S. Coppock some 50 years ago and although it is followed closely by a very small group of technical analysts, its calculation is not complicated at all.

You can keep track of it yourself. Here’s the recipe: you need historical monthly Dow Jones Industrial data. You add the 14 month ROC to an 11 month ROC, then you take a 10 month (simple linear) weighted moving average of the result. That’s it.

If you’re mathematically astute, you’ve already noticed that it is just another oscillator. Here is the chart of the Coppock Guide for the past few years, courtesy of InvesTech:

How is the Coppock Guide interpreted?
The most traditional interpretation is to recognize a buy signal when the Coppock Guide curls up while it is below the zero line.

It can also provide sell signals, although these are less frequent. If the Coppock curve makes a double top formation without first having come down to the zero line (or below it), the market is in for a seriously brutal bear market. You should be able to find one such occurrence in the chart.

So you can see why I think it is almost too good to share. In its history, only 4 false signals have occurred. That’s an 83% accuracy rate.

What is the Coppock Guide saying now?
The good news is that the Coppock Guide is in negative territory projected to fall into negative territory this month. So now any upturn can potentially give us a buy signal. The bad news is that this may happen next week, next month or next year.

The key factor is an upturn. But that can happen from an incredibly low level, like say in 1974 or 1932 (not shown) or it may happen just under the zero line, as in 1994.

Although no indicator can give a full iron clad guarantee, when the Coppock Guide turns up it would totally skew the probabilities towards a new bull market. As always I’m keeping a close watch and now that “the cat is out of the bag”, you can too.

Every trader prays for volatility because without it, prices wouldn’t move and there would be no chance to make a profit. But too much volatility can be as deadly as a quiet market. It would be a crass understatement to say that we are experiencing tremendous volatility these past few weeks.

The stock market has been either going up or down by at least 1%, for more than 70% of the trading sessions these past three weeks. This amount of volatility is both extreme and rare.

While stop losses are getting hit all over the place, the good news is that this level of volatility has a good track record of signaling important market bottoms.

A good measure of price volatility is the technical indicator known as “Average True Range” - developed by Welles Wilder in his 1978 classic: New Concepts in Technical Trading Systems.

As you can see in the chart for the S&P 500, the average true range is as high as it has been since 2002 (yet another indicator hitting these chronological extremes).

In case the graph is too small to see, the 2000 signal was for the mid April 2000 “mini-crash”. On a chart like this one, the fall and snapback rally may seem insignificant, but if you were there during those days, you would remember the harrowing experience.

And since I haven’t been featuring the venerable Dow Jones enough, here’s a chart for it showing similar signals:

During the cyclical bull market that started in early 2003, every time the market penetrated its long term moving average, it ricocheted off like a smooth pebble off a lake.

In hindsight, it looks quite orderly and beautiful (see chart). But each time the indices breach their 200 day moving average, it alarms a lot of investors and “experts” who start to pontificate about the importance of this simple technical indicator.

There’s nothing magical about it. In a bull market this behavior is normal. But in a bear market, the opposite is true - that is, the market is hardly given the chance to poke its head above the 200 day moving average and when it falls below it, it goes deep. In the summer of 2002, for example, it went more than 25% below.

The noticeable change is that since the intermediate bottom in August 2007, each subsequent trip below the 200 day moving average has been lower. After today’s shellacking we’re now -5.5% - a place we haven’t been in more than 4 years.

So is this it? Are we on the cusp of a new [gasp] bear market?

No one knows.

All I can do is to follow the technical and sentiment signposts that have been helpful in the past and try to use them to make some sense out of it all.

Although they never line up perfectly, most of the indicators I see are pointing to a correction. The most convincing argument is that investors and traders are reacting with complacency but fear.

I’ve already outlined the sentiment overview, and to that we can add today’s CBOE equity put/call ratio which reached 0.97 - a level that it reached before in mid November 2007, mid August 2007 and March 2007.