The Dot-Com Bubble In The United States Stock Market Crashes How To Capture The Big Moves

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How To Capture The Big Moves

Wouldn’t it be great to have an indicator to help tell you when we are in a major bull or bear market? Imagine if you had a clear signal to exit the market on January 18, 2008 before the major market crash. Then the same indicator told you when to get back into the markets on August 18, 2009. Such an indicator would have also gotten you out of the market during the dot-com crash on October 27, 2000. Well, this indicator I’m going to talk about does just that.

Below you will also find the EasyLanguage code for this indicator. This major trend indicator was inspired by an article entitled “Combining RSI with RSI” by Peter Konner and it appears in the January 2011 issue of Technical Analysis of Stocks and Commodities.

How It Works

We are going to start with a well known indicator: the Relative Strength Indicator (RSI). The premise we’re looking at is how to identify major bull market and bear market phases. In his article, Peter does this by simply using an RSI indicator on a weekly chart. Peter noticed that during bull markets the RSI rarely goes below the value 40. Likewise during a bear market the RSI rarely rises above the value of 60. Thus you can determine the beginning and ending on bull and bear markets when the RSI crosses these critical levels. For example, during the bear financial crisis of 2008 the weekly RSI indicator did not rise above 60 until August of 2009. This signaled the start of a new bull trend. The next bear trend will be signaled when the weekly RSI falls below 40. With these simple rules you are able to determine bull and bear markets with a surprising amount of accuracy giving the S&P futures market.

Modifying RSI

I personally found the RSI signal a little choppy. I decided to make two modifications to help smooth the raw RSI signal. First, the input into the RSI indicator I changed from the closing price to the average of the high, low and close. I then take this RSI signal and pass it through a 3-period exponential moving average function. The results look like this:

RSI_Mod = RSI( (c+h+l)/3, RSI_Period );

Signal = Xaverage( RSI_Mod, 3 );

Below this post the paintbar indicator and the strategy are available for download. They’re both very simple and use the standard RSI indicator. The RSI uses a length of 16 and is applied on the weekly chart. I also smooth the RSI value by using an exponential moving average of the last three reads.

Entry and Exit Dates

Using this indicator we come up with the following turning points for major bull and bear markets for the US indices.

The blowup of the dot-com bubble happened in 2000 and we got out in October 27, 2000.The indicator then tells us to go long on June 13, 2003. We then ride this all the way up to the financial crisis getting out of the market on January 18, 2008. Then on August 18, 2009 we go long.

How Can This Indicator Help You?

Looking at these dates we see that they are fairly accurate in capturing the major bull and bear cycles of the US stock indices. How can this be used in your trading? Well perhaps you can use this as a basis of a long-term swing strategy. Maybe this is an indicator to let you know when to liquidate your long positions in your 401(k) and other retirement accounts. Or perhaps if you are a discretionary trader you can use this to focus on trades in the primary direction of the market. Anyway I thought it was an interesting and novel way at looking at the RSI indicator. I hope you find it useful in your trading.

Download

The source code for this indicator is available at my website as a free download. See the link below.

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