Introduction
If traders back in the day would have had the modern technical analysis tools they could have forecasted the market crashes more easily. Once the past is gone it's gone forever, but we can always go back to learn from it. Those who ignore the past are doomed to repeat it. In this publication I back tested a couple of tools which basically detect the trend direction, trend strength and momentum.
Market at a Glance
The charts should follow the K.I.S.S. principle, (Keep It Simple and Stupid), the simpler the better. An indicator should provide as much meaningful information as possible without being overwhelming and without pushing the limit to the analysis paralysis level. I use the classical Madrid Ribbon indicator to determine the Bias at a Glance. This indicator is very simple, and it only needs one parameter, exponential moving average or the default simple moving average, the rest is done by the script. At a glance I can get the bullish or bearish bias by just looking at the color of the indicator, green for bullish, red for bearish.
The screams are all the same
When the market sells, it sells, at first there is no way to know if this is a selloff or just a profit taking and an opportunity to buy the dip. By looking at the indicators, I can determine if the vector is in the red, then it's a selloff, and probably the start of a bear market, if the vector is showing weak momentum, or if it is in the brink of going in the opposite direction. A selloff is not always the same, and the indicator can help to determine the best strategy to follow.
Going back to normal
After a bear market, once the indicators show a weak momentum to the downside it is time to get ready to load and wait for the confirmation of the reversal to the bull side. In the following examples I back tested the Madrid Ribbon and the MAdrid Vector to get an idea of how the indicators reacted under an extreme condition, like that of the market crash in 1929, the Black Monday of 1987, the Dot Com bubble and I finally used it to glance at the present market.
The Great Depression 1929
"The Roaring 20's" The feverish Stock Market. The time when everybody wanted to get in because everybody was making money. The Bull Market of 29 started in June 1924, when the Madrid Ribbon confirmed a Green Bull after a double bottom from November 1923 and May 1924. There was a reversal of the Bear trend in November 1921. The "Madrid Attack Vector'' indicator confirms the times of the duration of the trend. It shows a dull market in November 1922, a Peak and an exhaustion with a Bearish reversal. In May 1926 there was a painful correction, pinpointed by both the Vector and the Ribbon, a consolidation and a continuation of the Bullish market. In August 1928 the mass committed to the euphoric upward move for a juicy 60% return for the year. A correction and another leg of 30% which would make around 90% riding the trend with perfect timing. After this point the buying stopped. No more bidders, no more upside, smart investors and short term traders run for the exit. By lack of demand the ask price tumbled until it found bidders. This happened pretty fast but it is detectable. The initial drop was recovered (buy the dip) still in the bull territory, but there is a warning, the vector already displayed a divergence between the trend and the trend strength, it was weak and it is not a good sign, the trend had reached exhaustion and it's time to be extremely cautious. The correction made the index dipped -30%, after which point one wave of short sellers were covering their initial short positions, and some other dip buyers were stepping in. At this point, both Madrid Ribbon and Madrid Vector show the trend is already in bear territory, so this "back to normal" was only the start of the historic decline. It was not a free fall, it was a stepped fall with approximately -30% declines and recoveries of +20%, until the total market fall from peak to bottom reached -90%. The accounts were wiped off and the bankruptcies piled up. Both the Vector and the Ribbon show the "Sell the Peak'' points. Everything in the red means the Bear Market is going on, until the Vector shows a weakness in the selling and the Ribbon shows no new "Lower Lows" are made, this signals a Bullish Reversal.
Black Monday 1987
Once the Madrid Ribbon signaled the trend reversal going from red to green, the Bull Market was pinpointed to start in July 1984, from that point the Market went up, it reached 100% return from bottom to top, it corrected about 10% and kept on going until it peaked at 2700 points. By 1987 the computers had taken over the stock market, when several bulls took profit at around the target level, this event triggered the circuit breakers and liquidated the positions, the Flash crash took a dive of 35% from top to bottom. The Madrid Vector detected the last low momentum and the Madrid Ribbon detected the double top, this signals a momentum divergence and a possible reversal. Note that during the time the Dow Jones reached 1940 points and it started to consolidate. At some point the Madrid Vector signaled a low momentum and trend divergence, which didn't finish the bull market since the market found support. The old saying says "never short a dull market", it applies here, the Madrid Vector remained signaling a Bull Market with low momentum, but never went to the Bearish side. Nobody becomes poor by taking profits anyway. The market went for two more cycles, from July 1986 until April 1987 and the grand finale from May 1987 to September 1987. The expansion from the Madrid Ribbon shows the level of euphoria in the market. The Market became too complacent and overconfident. That's the point where there's liquidity in the market to exit at a profit if the entry was well calculated. This bear market didn't last for too long, and once the Madrid Vector signaled a low bearish momentum the market was ready to resume the uptrend.
The Dot Com Bubble
This case was similar to the Black Monday, euphoric market, almost no momentum to the upside according to the vector, a failed double top and a reversal. The low momentum signaled at the end of the trend is a sign of a reversal. The Madrid Ribbon shows the closing prices are already under it and in the red, this is a Bear Market. There are short recoveries where the short sellers and the target pivots act as temporary support, which is shortly after broken. This Dot Com Bubble shows a sign of relief in 2002, but the Madrid vector shows the little momentum to the upside, and not enough to trigger a trend reversal. It is on the second weak momentum point where the price starts to find a floor, there are less sellers and the institutional money is positioning. The uptrend was ignited in April 2003 and the bull rally started. The end of this leg is signaled also by these two indicators. The Ribbon shows a bearish development, the trend tries to go back to normal, but at this time the Madrid Vector already shows a very deep red level, the recovery is the "Going back to normal" trap which is used to liquidate the positions and ride the Bear.
Present Day 2021
2016 showed two big dips, one in August 2015, the second in January 2016, These were two big testing points, a double bottom that was used to see how firm the ground was before going long and strong in 2016. The red dips are shown in the Madrid Vector and the Madrid Ribbon. Once the trend picked up and the Market started to make new highs (HH) the euphoria picked up until January 2018 when a full expansion of the ribbons was suddenly stopped by a critical low momentum on the Vector, it is a divergence that signaled a reversal, the market tried to make a second top but the momentum was very weak and the market just consolidated. Later in September 2018 the market went for the double top on weak momentum, this is a very bearish sign that ended in "The Nightmare Before Christmas", plus the Santa Gift for those who traded on Christmas Eve and rode the late 2018 early 2019 Santa's Rally. A couple of dips with strong upward momentum on three waves and then COVID put a halt in the market. This is signaled by a weak bull momentum at the double top, again a bearish reversal. The only thing is this has been a huge reversal that practically wiped off the last four year rally. The market took the dip, the vector signaled a weak bear momentum and it is a sign of bullish reversal. The momentum was weak when the Madrid Ribbon was changing colors. This is the Support/Resistance fight, and the market could have taken another dive down to test its commitment, however the market decided to go in full force and the momentum started to timidly grow until what we see today. We have again a full bullish momentum, with an expanding Ribbon. So we're completely in the green and with an Euphoric market .... again.
If traders back in the day would have had the modern technical analysis tools they could have forecasted the market crashes more easily. Once the past is gone it's gone forever, but we can always go back to learn from it. Those who ignore the past are doomed to repeat it. In this publication I back tested a couple of tools which basically detect the trend direction, trend strength and momentum.
Market at a Glance
The charts should follow the K.I.S.S. principle, (Keep It Simple and Stupid), the simpler the better. An indicator should provide as much meaningful information as possible without being overwhelming and without pushing the limit to the analysis paralysis level. I use the classical Madrid Ribbon indicator to determine the Bias at a Glance. This indicator is very simple, and it only needs one parameter, exponential moving average or the default simple moving average, the rest is done by the script. At a glance I can get the bullish or bearish bias by just looking at the color of the indicator, green for bullish, red for bearish.
The screams are all the same
When the market sells, it sells, at first there is no way to know if this is a selloff or just a profit taking and an opportunity to buy the dip. By looking at the indicators, I can determine if the vector is in the red, then it's a selloff, and probably the start of a bear market, if the vector is showing weak momentum, or if it is in the brink of going in the opposite direction. A selloff is not always the same, and the indicator can help to determine the best strategy to follow.
Going back to normal
After a bear market, once the indicators show a weak momentum to the downside it is time to get ready to load and wait for the confirmation of the reversal to the bull side. In the following examples I back tested the Madrid Ribbon and the MAdrid Vector to get an idea of how the indicators reacted under an extreme condition, like that of the market crash in 1929, the Black Monday of 1987, the Dot Com bubble and I finally used it to glance at the present market.
The Great Depression 1929
"The Roaring 20's" The feverish Stock Market. The time when everybody wanted to get in because everybody was making money. The Bull Market of 29 started in June 1924, when the Madrid Ribbon confirmed a Green Bull after a double bottom from November 1923 and May 1924. There was a reversal of the Bear trend in November 1921. The "Madrid Attack Vector'' indicator confirms the times of the duration of the trend. It shows a dull market in November 1922, a Peak and an exhaustion with a Bearish reversal. In May 1926 there was a painful correction, pinpointed by both the Vector and the Ribbon, a consolidation and a continuation of the Bullish market. In August 1928 the mass committed to the euphoric upward move for a juicy 60% return for the year. A correction and another leg of 30% which would make around 90% riding the trend with perfect timing. After this point the buying stopped. No more bidders, no more upside, smart investors and short term traders run for the exit. By lack of demand the ask price tumbled until it found bidders. This happened pretty fast but it is detectable. The initial drop was recovered (buy the dip) still in the bull territory, but there is a warning, the vector already displayed a divergence between the trend and the trend strength, it was weak and it is not a good sign, the trend had reached exhaustion and it's time to be extremely cautious. The correction made the index dipped -30%, after which point one wave of short sellers were covering their initial short positions, and some other dip buyers were stepping in. At this point, both Madrid Ribbon and Madrid Vector show the trend is already in bear territory, so this "back to normal" was only the start of the historic decline. It was not a free fall, it was a stepped fall with approximately -30% declines and recoveries of +20%, until the total market fall from peak to bottom reached -90%. The accounts were wiped off and the bankruptcies piled up. Both the Vector and the Ribbon show the "Sell the Peak'' points. Everything in the red means the Bear Market is going on, until the Vector shows a weakness in the selling and the Ribbon shows no new "Lower Lows" are made, this signals a Bullish Reversal.
Black Monday 1987
Once the Madrid Ribbon signaled the trend reversal going from red to green, the Bull Market was pinpointed to start in July 1984, from that point the Market went up, it reached 100% return from bottom to top, it corrected about 10% and kept on going until it peaked at 2700 points. By 1987 the computers had taken over the stock market, when several bulls took profit at around the target level, this event triggered the circuit breakers and liquidated the positions, the Flash crash took a dive of 35% from top to bottom. The Madrid Vector detected the last low momentum and the Madrid Ribbon detected the double top, this signals a momentum divergence and a possible reversal. Note that during the time the Dow Jones reached 1940 points and it started to consolidate. At some point the Madrid Vector signaled a low momentum and trend divergence, which didn't finish the bull market since the market found support. The old saying says "never short a dull market", it applies here, the Madrid Vector remained signaling a Bull Market with low momentum, but never went to the Bearish side. Nobody becomes poor by taking profits anyway. The market went for two more cycles, from July 1986 until April 1987 and the grand finale from May 1987 to September 1987. The expansion from the Madrid Ribbon shows the level of euphoria in the market. The Market became too complacent and overconfident. That's the point where there's liquidity in the market to exit at a profit if the entry was well calculated. This bear market didn't last for too long, and once the Madrid Vector signaled a low bearish momentum the market was ready to resume the uptrend.
The Dot Com Bubble
This case was similar to the Black Monday, euphoric market, almost no momentum to the upside according to the vector, a failed double top and a reversal. The low momentum signaled at the end of the trend is a sign of a reversal. The Madrid Ribbon shows the closing prices are already under it and in the red, this is a Bear Market. There are short recoveries where the short sellers and the target pivots act as temporary support, which is shortly after broken. This Dot Com Bubble shows a sign of relief in 2002, but the Madrid vector shows the little momentum to the upside, and not enough to trigger a trend reversal. It is on the second weak momentum point where the price starts to find a floor, there are less sellers and the institutional money is positioning. The uptrend was ignited in April 2003 and the bull rally started. The end of this leg is signaled also by these two indicators. The Ribbon shows a bearish development, the trend tries to go back to normal, but at this time the Madrid Vector already shows a very deep red level, the recovery is the "Going back to normal" trap which is used to liquidate the positions and ride the Bear.
Present Day 2021
2016 showed two big dips, one in August 2015, the second in January 2016, These were two big testing points, a double bottom that was used to see how firm the ground was before going long and strong in 2016. The red dips are shown in the Madrid Vector and the Madrid Ribbon. Once the trend picked up and the Market started to make new highs (HH) the euphoria picked up until January 2018 when a full expansion of the ribbons was suddenly stopped by a critical low momentum on the Vector, it is a divergence that signaled a reversal, the market tried to make a second top but the momentum was very weak and the market just consolidated. Later in September 2018 the market went for the double top on weak momentum, this is a very bearish sign that ended in "The Nightmare Before Christmas", plus the Santa Gift for those who traded on Christmas Eve and rode the late 2018 early 2019 Santa's Rally. A couple of dips with strong upward momentum on three waves and then COVID put a halt in the market. This is signaled by a weak bull momentum at the double top, again a bearish reversal. The only thing is this has been a huge reversal that practically wiped off the last four year rally. The market took the dip, the vector signaled a weak bear momentum and it is a sign of bullish reversal. The momentum was weak when the Madrid Ribbon was changing colors. This is the Support/Resistance fight, and the market could have taken another dive down to test its commitment, however the market decided to go in full force and the momentum started to timidly grow until what we see today. We have again a full bullish momentum, with an expanding Ribbon. So we're completely in the green and with an Euphoric market .... again.