LEVEL 1
Rules Characteristics and Expectations (R.C.E.’s) based on historical distributions:
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Expect prices to slowly lead to higher highs for the stock market when the price of the S&P 500 is above Level 1.
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Do not expect prices to spike higher. When the price of the S&P 500 is above Level 1, prices frequently go up, or more precisely trend upward. When the price of the S&P 500 is above Level 1, it neither goes up quickly nor down quickly, particularly on a daily basis.
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When the S&P 500 is trading above Level 1, news reported on the TV (CNBC, CNN, Fox, etc.) will be interpreted as good for the market. News which is not good will also be reported, but it will either be ignored or interpreted as unimportant to stock prices while prices are above Level 1 (in almost all cases.)
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Many analysts will assume the market is short-term or near-term overbought, meaning they believe that markets have gone up too far, too fast. History shows this assumption to be incorrect nearly every time. Analysts know that markets go down after long periods of gains. Because Level 1 can only be reached by slow, steady gains, many analysts will prematurely anticipate a 5 - 10 % move downward in the near future. However, these large downward moves delay up to 6 - 12 months in many cases.
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TRADING RULES: Level 1
An absolute buy-and-hold rule on all closes above Level 1.
Sell on any daily close 1% below Level 1.
LEVEL 2
Rules, Characteristics and Expectations (R.C.E.’s) based on historical distributions:
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Level 2 has 2 phases:
Phase 1:
When the S&P 500 moves below Level 1, the MAV Tool enters Level 2 (Level 2 is the second highest girder and all the space between this girder and the highest girder.)
A common occurrence in a bull market is a break in Level 1 which holds Level 2, only to bounce back above Level 1 within 3 to 6 weeks. This pattern seems to make a lot of traders believe the market will move much lower in the near future.
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Phase 2:
A move above Level 2 is one phase in a bull market. Once price moves above Level 2, the market becomes more orderly. Consequently, expect daily moves in the S&P 500 to be under 2%; most daily moves will be less than 1.25%.
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TRADING RULES: Level 2
When price comes from under Level 2, buy on any market close above Level 2.
When price is dropping from above Level 1, buy 1% above Level 2.
Sell on any close 1% below Level 2.
Level 3
Rules, Characteristics and Expectations (R.C.E.’s) based on historical distributions:
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LINE IN THE SAND:
Level 3 delineates US markets as bull markets and bear markets.
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Every bull market since 1896 (118 years) has occurred above Level 3, and the market has always been characterized by decreasing volatility. No bull market has ever occurred below Level 3.
Every bear market in the history of the Dow Jones Industrial Average (and the S&P 500 since its inception in 1958) has accelerated losses below this level. The farther the index moves below this level, the greater the volatility and the faster the downward acceleration. Note: It is not wise or prudent to invest in the market to go up when price is below Level 3.) 118 years of US stock market history tells us to invest in the market to go down below Level 3, or to move assets to cash.
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TRADING RULES: Level 3
Level 3 is the only level with absolute rules regarding long and inverse positions:
A close 1% or more above Level 3 is an absolute buy.
A close 1% or more below Level 3 is an absolute sell or Inverse Investment.
Level 4
Rules, Characteristics and Expectations (R.C.E.’s) based on historical distributions:
When the price of the S&P 500 is below Level 5, the state of the economy, jobs and just about everything else looks really bad.
In bear markets, there are weeks and/or months in which the S&P 500 remains below Level 4, yielding extreme profits for inverse investments.
When the index is below Level 4, volatility is extreme.
Intraday moves — up or down — of more than 4% are common.
There will be times when this signal gets an investor in and out of the market often (this is the nature of volatility.)
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Trading Rules: Level 4
Inverse investments should be exited 1% above Level 4.
Inverse investments should be re-entered when the S&P closes below Level 4.
Level 5
Rules, Characteristics and Expectations (R.C.E.’s) based on historical distributions:
Like Level 4, when the price of the S&P 500 is below Level 5, the state of the economy, jobs and just about everything else looks really bad.
Nearly every piece of news is interpreted as devastating.
In the 118 years of the Dow Jones Industrial Average, Level 5 has shown a bottom in the market is near (from the perspective of time), but that an investor cannot take much comfort in this fact as 10 - 20% losses in the market over this extremely short period are not uncommon. The S&P 500 has the same pattern for its 56-year history.
Many 4 - 7% days (both up and down) are to be expected.
There will be times when this signal gets an investor in and out often (this is the nature of volatility).
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Trading Rules: Level 5
Inverse investments should be exited 1% above Level 5.
Inverse investments should be re-entered when the S&P closes below Level 5.