Market Breadth Primer: Advance / Decline Spike Low

By Lawrence

An interesting usage of advance / decline issues is to identify the market extremes. Here is one setup that has emerged as one of the best short term bottom picking signals since year 2000.

Following chart marks the points where the signal occurred.

ES Advance Decline Patterns_20130516_122713

The most powerful thing with this setup is that if the market is going higher, it happens the very next trading day.

The Setup

1. Advance Issues / (Advance Issues + Decline Issues) <= 0.25 two days in a row

2. Open greater than close on the signal day

It is simple and it works.

Variations

You can lower the threshold form 0.25 to 0.24, 0.23 or even lower to reduce the total number of signals but it is not necessarily a good idea as the best reversals do not correlate well with more extreme selling. They correlate more with the context on how the market sold off into these extremes.

The price filter can be removed and it will still work, just that the reversal would have happened on the signal day and leaving not much room to go higher for the next trading day. As a longer term signal, the price filter can be removed with your own rules to improve the entry.

Notes

For daytraders, it may not be as useful as the statistical biases you get from Market Breadth Primer: Advance / Decline Issues since this setup only occur a few times a year. But it is a very strong setup that daytraders should be aware of. Turning into roadkills by the raging bulls who step into the market to pick bottom, or a floodgate of shorts covering their positions, is not funny.

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