There are two types of market conditions… 1) trending and 2) trading ranges. It is VERY important to know which type of market condition exists at any given time…
Most ‘trading systems’ are designed to exploit one type of market condition or the other. The problem with those trading systems is that a ‘trending’ system gets killed in a rangebound market–and a ‘range trading’ system gets killed in a trending market. That’s why the vast majority of ‘trading systems’ don’t work over the long haul.
Stops and Targets is actually a trending system embedded in a range trading system with a spotter system thrown in for good measure. It analyzes and adapts to the current conditions. Let me show you how it does that…
The screen capture above comes from my post here on January 16th, which is the date when the first batch of internal top spotter signals warned that something was changing.
Take a look at the ‘range envelopes’ indicator at the top of the screen…
To the left of the range envelopes, you see green trending arrows ↑ by all three timeframes. Those up arrows showed that each timeframe was trending. When a market is trending bullish, the stop/reverse line (trending component) is equal to the range bottom (trading range component) and that is what we see in the example above.
Note: The opposite is true in trending bearish markets when we see a red down arrow ↓ next to the range envelope. In that case, the stop/reverse line would be equal to the range top.
Trending markets are wonderful things… because when a stock is at a new high in a bull market, for example, everyone who is long that stock looks like a genius. In a trending market one only needs to buy the dips and then hang on while moving the trailing profit stops up behind the move. Protection of profits is easy when you have stop/reverse lines to use as guidelines for trailing stops.
At some point, however, all trending markets reach a point of exhaustion and then either correct or reverse…
For the current market, that point of exhaustion came on January 29th. On that day there was a Top Spotter Alert in the futures (shown by the magenta arrow on the chart above).
So, there was Stops and Targets saying ‘hey, we have a potential exhaustion in this amazing trending market’. That is the Spotter component of Stops and Target’s three embedded systems giving an early head’s up that a possible reversal was in the works.
That Top Spotter alert was confirmed the very next day as price dropped from the all-time-high at 2878.50 to a touch of short-term range support at 2825.50. The market tried to bounce there for the next two days but on February 2nd short-term support failed and we got the first timeframe SELL at 2825.50.
Once the short-term sell was added to the confirmed Top Spotter we knew that the next downside target was the intermediate stop/reverse line at 2708.50. Price wasted no time getting there–but the selling momentum was so strong that price blew right through intermediate support and turned that trend bearish as well at 2708.50. Once that happened, the next target lower came into play, which was long-term trend support at 2558.29.
Price bounced right on cue at long-term support and we got a Bottom Spotter Alert on the poke below to 2529 on February 6th. That bounce at long-term support along with the Bottom Spotter meant that is was definitely time to cover and celebrate for the nimble bears who sold the breaks at short-term and intermediate support.
We had the initial short-covering bounce followed by a double bottom at long-term support and that was the time for everyone to BUY at the bottom of the long-term range. Technically, that was a short and intermediate term pullback to long-term support. The pros wasted no time in getting the takedown job done–but corrections are necessary and normal in bull markets and this recent run-up had gone a very long time without backing and filling.
Now, let’s take a look at where we are currently using Stops and Targets in conjunction with my chart above…
Let’s focus in again on the range envelopes indicator at the top center of the screen capture…
Start with the dates to the right and go from oldest to newest and this is what that indicator is saying in plain English…
The S&P 500 Futures showed a counter-trend pullback at 2878.50 in the long-term timeframe on 29-Jan-18. A countertrend buy signal was detected on 06-Feb-18 at 2529 in the intermediate timeframe. After a rally we most recently got a short-term countertrend sell signal at 2789.75 on 27-Feb-18.
See how that works?
But what I really want to point out about all of this is the important change in arrow types next to the range envelopes. Note that we now see sideways arrows ↔ next to all three timeframes and NOT ↑ green UP arrows any longer. Notice also that the range envelope bottoms do NOT equal the stop/reverse lines anymore…
What we have currently is a rangebound (trading range) market. So, naturally, what worked in a trending market doesn’t work in a range-bound market. Now we are watching the edges of the trading ranges as this market recovers from that violent pullback from 2878.50 to 2529, which you will notice is the current long-term and intermediate trading range envelope.
The short-term range is currently dynamic, however, and that is what I pointed out in my last post. The short-term was trending bearish from 2/5 to 2/15 which caused the stop/reverse line to follow the range top lower–but the rally crossed the top of the range and the bearish stop/reverse line at 2701.75, which ended the bearish trend and set up the current short-term trading range between 2682 and 2789.75. That explanation might hurt your head a little but just look at the dotted short-term range lines on my chart above and you will see what I mean.
The short-term is trying to move higher and we see a higher high and higher low structure to the range envelope–but the key is the short-term range envelope bottom which is currently at 2682. What bulls want to see next is for the short-term range to start trending again and for the range envelope bottom to eventually cross over the current stop/reverse line at 2701.75–but that can only happen if the current range bottom holds and price eventually heads back up to cross over the range envelope high.
The way to fine tune the read here is to say the short-term is currently rangebound between 2789.75 and 2682. A countertrend pullback signal targeted the stop/reverse line at 2701.75 with the next pullback target being 2682.
So that’s where we are… currently in a rangebound market in all three timeframes. We are now watching closely to see if the current short-term pullback can find support and then move higher–or alternately, if the short-term range envelope bottom were to fail then sellers would be back with a vengeance looking to next challenge the intermediate range bottom.
To understand the way range envelopes work it helps to know that the three major timeframes used by the pros are predicated by weekly, monthly, and quarterly cycles. Therefore, the short-term timeframe is the lowest low and highest high of the past trading week, the intermediate is the lowest low and highest high of the past month, and long-term is the lowest low and highest high of the past quarter.
So, with that said we can see that because the low of the current daily bar has poked underneath the short-term stop/reverse line at 2701.75 it will be at least a week from now before we could see the short-term start to trend higher and then as a result start to drag that stop/reverse line higher as well into a BULL 10 rating. Of course, if the range bottom fails then we could start to see a bearish trend begin in as little as three trading days.
Bottom line is that until we see a breakout on one side or the other of these ranges–this is a fully rangebound market and those range extremes are where the trading action will likely occur.
Today’s early low at ES 2698 is the bull/bear line right here (in my opinion). If that low holds then we should see the short-term range envelope continue to narrow in a higher-low/ higher-high bullish pattern at the close today.