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Tuesday, April 14th, 2009

How to tell a new bull market has started

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The last two posts have talked about the nature of the current rally and whether we’re at the start of a new bull market, or whether it’s just another bear-market rally.

The question remains: how do we know if we’re in a new bull market?

It’s pretty simple: when both short-term and long-term market indicators are bullish.

Short term indicators might include: the market trading above its 50-day moving average, gains in the market on strong volume, and the daily and weekly MACD indicators in buy mode.

Long-term indicators might include: the monthly MACD in buy mode, the market trading above its 50-week moving average, new 52-week highs higher than 52-week lows, and the market in an uptrend; ie making higher highs and lower lows on a weekly chart.

The problem is there is often considerable time between when the market rallies, which makes the short-term indicators bullish, and when the long-term indicators turn bullish.

By definition both bear market rallies and the start of the bull market begin with the short-term indicators turning bullish, like they are now.

So what do we do? Do we wait for the long-term indicators to turn bullish before buying? That is certainly a valid option. The risk is you give up early gains of bull moves; the reward is that you avoid being sucked into lots of bear market rallies.

Another option is to phase into the market. An example might include:

1. Increase market exposure to 15 per cent to 30 per cent when the market:

- Makes a strong volume move during the early part of a rally (similar to a William O’Neil follow-through day)
- Trades above its 50-day moving average
- The weekly MACD turns bullish

2. Increase market exposure to 30 to 70 per cent when the market:

- Begins making higher highs and lower lows on the weekly chart
- New 52-week highs are greater than new lows
- The monthly MACD turns bullish

3. Move to 100 per cent (plus) exposure when:

- The market trades above its rising 50-week moving average

If this strategy is applied without discretion – particularly at the start of a bear market – you’ll be sucked into plenty of bear market rallies, though with less exposure.

This is where Dow Theory and cycle phase analysis becomes so important. It provides a tool to indicate that there is a greater probability of a rally turning into a bull market.

By phase analysis I mean, for example, using the three phases of Dow Theory, which I’ve discussed in the previous few posts.

For example, when we enter Phase Three of a bear market, ‘distress selling’, we know the chance of a rally turning into a bull move is greater.

When we decide we’re in Phase Three and the market rallies, we look for aggressive-growth stocks hitting new highs. We take some positions, but limited to, say, 15 to 30 per cent of the portfolio.

The usual rules apply: adhere to strict risk management (ie risking no more than 1 to 2 per cent of your portfolio) and cutting losses quickly. There is every chance that it is another bear market rally that could fail quickly.

Often I find that my system is in Phase Three and it rallies, but there is little or nothing to buy; ie no company with accelerating or explosive earnings growth whose share price has had strong price momentum and is hitting new highs. Finding suitable candidates is the final filter that overrides everything.

Dow Theory is subjective. But trading isn’t about knowing what will happen, it’s about examining the environment we’re operating in, weighing the odds and adjusting strategy accordingly.

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This entry was posted on Tuesday, April 14th, 2009 at 3:25 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.