Ian Woodward's Investing Blog

Early Warning Signs for a Correction

Michael Kahn of Barrons asks:

If I am not mistaken, there was a pheonix last week followed by a eureka. Since we are  25% to 30% into a rally, a eureka is supposed to be exhaustive even w/o the phoenix.

sell?

Michael:  I wish it were that easy, but you have it “half-right”.  An Eureka Signal will indicate the Bulls have irrational exuberance.  Where it happens is the clue.

1. Several Eurekas in a row after a Base Low is a strong signal that a new Bear or Bull Rally is starting.
2. However, a Eureka late in the Rally also signals an Early Warning Sign that the Rally is probably over for now and a correction is due.  However, that alone does NOT constitute a SELL signal.  I have attached a PowerPoint slide below as to the entire rationale.  You heard it here first! 

early

Best Regards, Ian.

7 Responses to “Early Warning Signs for a Correction”

  1. Michael Kahn Says:

    C’mon Ian, my readers want a magic bullet, and not the one that makes pesto sauce in 9 seconds. 🙂

  2. David Galardi Says:

    Michael, Your a good soul.

    The magic of the bullet is the smoothie it produces. The idea to convey to the reader is to make sure the bottom is properly fastened, or the whole lot will be on the kitchen counter! For me, I am going to sit in mostly cash for a few more days!

    David

  3. Charlie Willey Says:

    Ian –

    I try to cheat a little with respect to Moving Averages by counting back the number of days in the average to see what is being subtracted off the back end of the average and comparing that number with the number that is being added on a given day to the front end of the Moving Average. With a 13 day SMA that is easy just count back 11, 12 and 13 days to see what will soon be subtracted. Speculate prices over the next 1,2 or 3 days to see what will be added, then make a tentative calculation.

    With the EMA that becomes a bit more complicated. I have looked for your formulation for the EMA and have not quickly found it. Is the impact of the price jump on May 4 nearing the point of being at the back end of the high impact dates and therefor getting ready to have a bigger impact on the 13 day EMA? In other words, can you remind us how the 13 day EMA is calculated? Sorry for the ignorance.

    – Charlie Willey

  4. ian Says:

    Hi Charlie: Your question had me scratching my head as it has been a while since I played with “raw” data on SMA’s and EMA’s, so I confess I had to go back to ChartSchool to refresh my memory, but here’s your answer, below. I used the example in the url below and modified it to accommodate 13 days instead of 10. The example they used was Eastman Kodak (EK), and they have a useful Spreadsheet which you can download and it shows all the formuas. I modified it for 13-days. The important thing to remember is that the exponential moving average puts more weight on recent prices. As such, it will react quicker to recent price changes than a simple moving average. I hope this helps. Ian.

    http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:moving_averages
    EMA Period (N): 13
    Smoothing Constant (K): 0.142857143

    Previous
    Close Period’s 13-Day
    Period Date ( C ) EMA (P) EMA (X)
    1 09-Nov-99 $64.75
    2 10-Nov-99 $63.79
    3 11-Nov-99 $63.73
    4 12-Nov-99 $63.73
    5 15-Nov-99 $63.55
    6 16-Nov-99 $63.19
    7 17-Nov-99 $63.91
    8 18-Nov-99 $63.85
    9 19-Nov-99 $62.95
    10 22-Nov-99 $63.37
    11 23-Nov-99 $61.33
    12 24-Nov-99 $61.51
    13 26-Nov-99 $61.87 $63.195
    14 29-Nov-99 $60.25 $63.195 $62.774 *
    15 30-Nov-99 $59.35 $62.774 $62.285
    16 01-Dec-99 $59.95 $62.285 $61.951
    17 02-Dec-99 $58.93 $61.951 $61.520
    18 03-Dec-99 $57.68 $61.520 $60.971
    19 06-Dec-99 $58.82 $60.971 $60.664
    20 07-Dec-99 $58.87 $60.664 $60.408

    EMA(current) = ( (Price(current) – EMA(prev) ) x Multiplier) + EMA(prev)

    (2/(Time periods + 1)) = (2/(13 + 1)) = 0.142857 (14.29%)

    * =(.142857*(60.25-63.195))+63.195 = 62.774

  5. Charlie Willey Says:

    Ian, great link. I didn’t think about going to stockcharts. I have spent about 5 minutes with the link but have to go with my wife to a baseball game. I will dig deeper into this tonight or tomorrow afternoon. I see the 13 day you have been talking about trying to roll over and wanted to see what to expect from possible index closings over the next few days. Thanks. – Charlie Willey

  6. ian Says:

    Hi Charlie: A word of caution now that I give this more thought. My short-hand statement should have read “13-ema FORCE Index turns negative”, since that is what must turn negative for us to see a significant enough drop to cause the Index to drop below the 17-dma.

    My quick look at this suggests we will need a 50 point drop in the Nasdaq to kill two birds with one stone: a negative 13-ema Force Index and a fall below the 17-dma. That would probably be enough to get us all four conditions I indicated with an asterisk in this study.

    The bottom line is it will require one more big sell off day like the one we had on Thursday.

    Best Regards, Ian.

  7. Charlie Willey Says:

    Ian, thanks for the closer look. I had already realized this but had not initially. I guess we can call this a good catch for both of us. Thanks for all of your hard work. – Charlie

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