So naturally, an important question for traders is how to objectively detect whether or not the bull run has ended by using charts.
My chart above aims to do that by using statistical tools. The chart uses a log-linear regression channel on the monthly chart of SPY to measure whether or not the bull run is intact. To create this log-linear regression channel, I added the "Linear Regression (Log Scale)" indicator by @Forza . I also added the "Linear Regression Formula" by @alexgrover to better gauge smaller scale trend reversals.
I modified the log-linear regression channel settings to include the entire period of the bull run following the Great Recession. More specifically, my look back period is from the bottom of the Great Recession (Count: 162, since it occurred 162 months ago). I kept the standard deviation at 2. A standard deviation of 2 means that this channel is likely to contain 95% of all price action.
Here are the ways that I use this log-linear regression channel to determine whether or not the bull run is still intact:
If price closes below the lower channel line, the next monthly candle must move back up and, at a minimum, tag the lower channel line. (This shows that buyers are coming in to buy the dip)
The linear regression line (the thin oscillating red line) cannot fall below the lower channel line of log-linear regression channel at the time of any monthly close. (If this line falls below the lower channel line it could resist price as it attempts to re-enter the channel, which in turn could signal an end to the trend).
Once price closes below the lower channel line, and then recovers to close above the lower channel line, price cannot then close below the channel again without first reaching the mean (red center line of the channel). (See below for illustration)
This last rule is important because it signifies that there were not enough buyers who were interested in buying the dip so as to enable price to recover to the mean.
If any of these rules fail, then it is a sign of weakness and the bull run that has been in place since the Great Recession may be ending.
My chart also shows overthrows, or periods when price thrusts above the 2nd standard deviation from the mean. (See chart below)
When the linear regression line crosses above the upper channel of the log-linear regression line that sends a signal that we are near a market top. In November 2021, the monthly SPY candle formed a bearish inverted hammer, which sent an additional signal that we are near the top. These signals are opportunities to become more defensive (e.g sell call options, begin to trail and narrow your stop losses for long position, stop adding new long positions).
Some traders may ask: What is the difference between a log-linear regression channel and just drawing a channel using candlesticks closing prices? The answer is that in the case of a log-linear regression channel the channel is derived mathematically from price action using a mean and standard deviations. One benefit of this method over drawing a channel using price action is that you can better detect overthrows and underthrows. This is to say that rather than drawing a wider channel to include all closing prices, a log-linear regression channel draws a narrower channel and signals high-probability buying and selling opportunities when price closes below or above the channel, respectively. Another difference is that a regression channel will not be as skewed by an outlier candlestick.
Aside from helping to determine if the bull run is over, this chart can help you decipher whether or not bullish predictions are realistic. For example, there are bulls on Trading View calling for SPY to reach 600 next year, unfortunately, that's unlikely to happen. In fact, based on this log-linear regression channel, the probability of that happening is less than 2.5% because it would require SPY to thrust above the upper channel line (2 standard deviations from the mean) of the log-linear regression channel. (See below for a diagram)
In summary, the stock market may seem like a roller coaster that randomly takes drastic swings, but the highs and lows of these swings are quite predictable.
Thanks for sharing. Can you give any target for possible completion of recent rally?
SpyMasterTrades
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@SaeedSajedi, The recent rally in my opinion is a fairly basic Wyckoff accumulation pattern. This week has been flushing out the shorts with a mild to moderate short squeeze. However, we're entering a time of year when stocks usually drop and volatility increases. This year will be no different. So the next move likely will be SPY dropping back down at least to late July levels as smart money tries to flush out longs and trap shorts at the bottom. Depending on how much volatility we see between now and late October, SPY is either going to hold just above the June levels or go slightly below them but then rebound back above. Finally, in my charting I see that SPY absolutely must close the year higher than it closed in June. This last point has a high probability. Whereas if there is a black swan event (or a known event like a US-China armed conflict that escalates) that sends the market lower in December, then we are in big trouble as this means the bull run is formally over. If you apply the WaveTrend oscillator by LazyBear to SPY on a 6M timeframe you will see that unless December closes quite a bit higher than June, we are likely in the throws of a more significant downturn. The last time this occurred on that oscillator was in early 2008.
SaeedSajedi
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@spy_master, Thanks for your informative answer. Great.
louistran_016
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@spy_master, thanks a lot for the insight. Let's hope even in case of a black swan event it's not China US war (hence NATO and a world war to follow). I see a fairly high chance of the nasdaq revisiting 200 WMA (June low) and confirm a double bottom. SPY 200 week MA however is 2.5% lower than June low (currently 357), so MA either has to catch up fairly fast, or the next leg down will induce massive panic. In case 357 doesn't hold and a 2008 kind of scenario plays out, SPY might drop an additional 24 - 27% from June low, we are in a very significant downturn and possibly turn 2020s decade into a sideway trading range
SpyMasterTrades
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@louistran_016, Thanks for much for sharing this. I agree. Let's hope for the sake of humanity there is no war. I completely agree with your thoughts on a sideways trading range for a decade - that is very possible and consistent with stagflation. Most retailer traders today only know the bull run that's been in place since the Great Recession. A lot of people are going to be disappointed.
cryptozen77
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I reproduced the chart for Bitcoin using 132 months - Aug 2011:
SpyMasterTrades
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@cryptozen77, Amazing! Thanks for sharing. Although it looks like a perfect fit, I'm going to write a very dense reason for why this channel won't work on Bitcoin in the long term. For Bitcoin, I would recommend rather than using a log-linear regression channel, to use a Bitcoin Log Growth Curve indicator. While a log-linear regression channel will help us track the break of the bull run on the S&P 500 and the Nasdaq's decades of nearly exponential growth, it doesn't work if you apply it on the entire price history of an asset. That's because virtually all assets, Bitcoin included, grow in logistic growth and not in exponential growth (a log linear regression channel only works on assets moving exponentially). So this is why the tool can only be used to catch trend breaks because no asset can remain in the channel forever. One note is that assets that are following exponential decay will remain in this channel endlessly until the trend ends. In fact, one great way to catch trend reversals from exponential decay is to use log-linear regression channels. Here's an example of tracking an asset in exponential decay to monitor for a breakout:
Ryan1993
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@spy_master, Great point, Ill keep an eye on this security in the future. Are there any in the past that you have taken advantage of this change and this breakout from exponential decay. I would love to see an example! What however is the difference between a Log-Growth curve and a linear-regression channel. Can all securities that are in logistical growth be mapped out on a log-growth curve. Also is there such thing as a logistical decay.
sokiee
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Very interesting take! At least initially this does seem to indicate that June was indeed an ( intermediate or not ) bottom and we will see an uptrend.
SpyMasterTrades
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@sokiee, Yes the June low for the S&P 500 was significant. It actually was the 3rd Fibonacci spiral from the Great Depression how. However, based on my charting, I'm quite convinced that this bull run will end no later than 2023. For more information you can check out my post: