The State of the Market is NOT one of our proprietary strategies. The State is a snapshot of what some of the simple indicators we’ve shared on this blog are saying about the market right now. Join our special SOTM RSS, Email, or NEW Twitter feed to be notified when this report is updated each day. And don’t forget the Addendum.

[INSERT IMAGE]

About the State of the Market Report

The State is a daily prediction of next-day returns on the S&P 500 (and other broad U.S. indexes) based on a number of simple strategies we’ve discussed on this blog:

Daily Mean-Reversion, DV(2) Mean-Reversion, Scaling In & Out of RSI(2), Falling 10Y Treasury Yields, the Golden Crossover, Generals Lead the Troops, two proprietary overbought/oversold indicators we use often in our own trading, and our new monthly Seasonality Map. Read more about how each strategy performed in 2009.

Three Timeframes

The State divides its daily prediction into three timeframes: the short, intermediate, and long-term, each driven by a different set of strategies.

The long-term prediction is a read on the overall tone of the market (think trend-following), the intermediate-term on shorter market cycles (most swing-trading), and the short-term on how overbought or oversold the market is based on just the last few days (aggressive swing-trading).

Unlike the original SOTM report, we now break the daily prediction down into three timeframes because there is no one size fits all answer – the State has multiple uses depending on the individual investor. Short-term traders (like us) might heavily weight short and intermediate-term predictions, expecting to make big position changes daily. Less aggressive investors might focus on the longer-term predictions, expecting to catch broad market themes. The report respects that difference.

Read more about the difference between short, intermediate, and long-term indicators, and how different types of traders (a sleepy trend-follower and an aggressive swing trader) might make use of the different predictions in this report.

A Little Less “Binary”

We’ve stuck to the spirit of how we originally described/tested each strategy, but in most cases, we’ve made some small modifications so that each strategy is a bit less “binary”. Generally speaking when we test ideas on this blog they tend to be either “all in” or “all out”. That’s fine for a proof of concept, but real trading success respects the market’s shades of grey.

For example, rather than just use 50/200-day moving average crossovers for the Golden Cross, we take the average result of 50/150-day, 50/175-day, 50/200-day, close/150-day, close/175-day, and close/200-day variations. Each is of course very similar to the original, but when combined will scale in and out of positions (like a “dimmer” and not a “light switch”).

Read more about binary versus polynary (aka “transactional” versus “confidence-based”) trading.

The “Reliability” Metric

Not all strategies are created equal. A strategy’s effectiveness will wax and wane as the market evolves over time.

The “reliability” metric (right-hand column) is a simple means of capturing that by measuring how effective each strategy has been over the previous 5-years. We then use the result to weight each strategy in the final short, intermediate, and long-term prediction. As a strategy becomes more/less effective, it makes a larger/smaller contribution.

Abnormal Market Filter

In addition to the individual strategy predictions, we also report the daily reading of our Abnormal Market Filter (AMF). The AMF is a measure of how “stretched” the market is based on the premise that when the market becomes stretched to extremes it becomes less predictable and more difficult to trade. The AMF travels between 0 and 100%, but will usually read 0% (meaning the market is “normal”).

The AMF doesn’t impact any of the results on this report, but in our trading, as the AMF increases we reduce position sizing. Using our YK strategy as an example, if the AMF reads 50%, we reduce our normal position sizes by half. If it reads 100%, we stay completely out of the market.

Read more about the Abnormal Market Filter.

Most Importantly…

The State is a way for us to bring some of the simple effective ideas we’ve talked about on this blog together in one convenient location. It is not and should never be construed as investment advice…ever (and by “ever”, I mean EVER).

Join our special SOTM RSS, Email or NEW Twitter feed to be notified when this report is updated each day (note: not the same as our blog feeds).