How I Tell If the Market Is "Going Up"

Over the past couple of years, I have written articles about whether the stock market has bottomed out or topped out, meaning has it hit an inflection point for awhile? I also wrote several articles about why I thought last year's rally was sustainable, which turned out to be accurate. I wrote an article a few weeks ago that opined that I thought the market had probably topped out for awhile after it hit 1150 and then fell backward. I was wrong: After dropping more than 8% and hitting my sell stops, the market reversed back and resumed a slow upward trend. It passed through 1150 a couple of days ago, and it finished at 1166 today (Wednesday).

And I continue to write the bi-weekly Timing Outlook articles that use a formulaic system to project the market's likely direction for 2-4 weeks. Those, while of course not infallible, have had a high batting average.

One point I have not nailed down: If my sell-stops get hit, and therefore my Capital Gains portfolio has cash rather than being 100% invested, how do I know whether and when to start re-investing the money? I have been vague about this, simply stating that I like to see the market "going up" for 2-3-4 weeks before I conclude that it may be in an "investable uptrend."

In this article, I want to get more specific about that. What follows is still a hypothesis, not a prescription. But here is what I have been doing.

1. I start with Ned Davis’ definitions of a bull market. (Ned Davis Research is a respected, fact-based research outfit.) Their two definitions of a bull market are:

• A: Market rises 30% over 50 calendar days (which equals about 36 trading days or about 7 weeks)
• B: Market rises 13% over 155 calendar days (about 110 trading days or 22 weeks)

Clearly, the first definition is for a fast-rising, sudden upturn, while the second defines a slow-but-steady rise.
To my eyes, the second definition is a little lenient. So I toughened it up by requiring a 20% rise rather than a 13% rise over the same time period. I chose 20% because it matches the common definition of bull market (a 20% rise in the market). So my modified "B" bull market is defined like this:

• B: Market rises 20% over 155 calendar days (about 110 trading days or 22 weeks)

2. We must make investing decisions in real time, without the luxury of waiting 22 weeks. I refer to these shorter decision-making periods as "investable" markets. The question becomes, at what point will I decide that the market is in an "investable uptrend"?

I answer this by taking the bull market definitions (A and B) and slicing them into shorter time periods. I also add a requirement: that 2/3 of the trading days have to be “up” days. This prevents one gargantuan "up" day from creating an "investable" market all by itself. What results is this:

• 2 weeks: A: 9% rise with at least 7 positive days (out of 10 trading days). "B" produces no signal, because the rise required would be less than 2%, which seems meaningless.
• 3 weeks: A: 12% rise with at least 10 positive days (out of 15). B: 3% rise with at least 10 positive days (out of 15). Since B is more lenient than A, it makes A moot.
• 4 weeks: A remains moot. B: 4% rise with at least 14 positive days (out of 20).
• 5 weeks: A remains moot. B: 5% rise with at least 18 positive days (out of 25)

3. So, to summarize, here are the qualifications for an "investable uptrend":

• 9% rise over two weeks, with at least 7/10 days positive
• 3% rise over 3 weeks, with at least 10/15 days positive
• 4% rise over 4 weeks, with at least 14/20 days positive
• 5% rise over 5 weeks, with at least 17/25 days positive
• Etc.

These are the standards I have used to get back into the market after my sell stops got hit in late January and early February. The market reversed itself and started going back up, and I made my first purchase on March 4, after it had been going up for about 3 weeks. Ever since then, I have been making one or two purchases per week, so long as the "investable trend," as defined above, has remained intact, which it has through today. I'm buying back in 10% chunks of the portfolio's total value. As of today, the portfolio is about 67% invested, and I have an order for execution tomorrow that will take that up to about 75%.

For risk management, I am using pretty tight sell stops, around 6% on all holdings. As you probably know by now, I use sell stops on all holdings in my Capital Gains portfolio. I do not use them in my Dividend Portfolio, preferring other approaches to risk management in a dividend growth strategy.