My most expensive episode of charting truancy occurred around the early-stage bull market of 2009. As Wall Street headed for rock-bottom, the weekly relative-strength index (RSI) began to improve. Then, as the US indices began to rally, they posted a buy-signal on the Coppock indicator. Despite having witnessed these bullish phenomena in 2002-03, and having resolved to respect them next time, I roundly ignored them and stuck to my bearish line. I got my backside handed to me on a plate - and deservedly so.
A bullish lesson ignored
I also bunked off school around the significant high in the market of spring of 2011. The Dow Jones formed negative divergence on its weekly chart, while I knew that the Federal Reserve’s quantitative easing was coming to an end. And yet, I decided to keep running with the bulls. Once again, I was summoned to the headmaster’s study and given six-of-the-best for my inattention to the charts.
How I missed 2011's top
I always like to keep these painful lessons in mind, but especially after long periods when I've been consistently right about the trend. It's at those times that the danger is greatest of blinding oneself to the facts and sticking with what's worked so well to date. And I am acutely aware that now could well be one of those times. We’re four years into a major uptrend, and things have been going particularly well since November.
To my eyes, the current conditions in UK and US are beginning to resemble those that preceded the big corrections of 2010, 2011 and 2012. The Dow and FTSE have both registered overbought readings of above 70 per cent on their weekly relative strength indices. And, the eruption of the Cypriot banking crisis in recent days is reminiscent of the eurozone turmoil that has been behind so much of the turmoil of the past three summers.
Overbought Dow
So far, the indices have held up pretty well in the face of the Cyprus affair. After the initial violent sell-off of Monday 18 March, they have recovered their poise and are merely chopping sideways not far below their recent highs. This has made day-to-day trading a bit tricky, as the rallies have tended to get reversed rather quickly. Getting stopped out is all too easy under the circumstances. The overall uptrend remains fully intact for now, though.
FTSE's potential divergence
The overboughtness on the RSI would become more worrying were the indices to head to new highs, but their RSIs did not do the same. For this to happen, we would first need to see a bit more of a pull-back or some more extended sideways action, followed by a rally. Even then, though, the markets would not become an automatic 'sell.' I would merely reduce the size of my positions and perhaps shorten the length of each trade.
In the end, the key difference between the three previous years and today comes back to monetary stimulus. What really pulled the rug from under the equity markets was the withdrawal of quantitative easing, or at least the anticipation thereof. For now, of course, there is no sign of this happening. In light of this, history's lesson is that I should continue to buy the pull-backs, both intraday and any deeper ones. It is one I intend to heed.
