Be Wary of New Buy Signals
by Carl Swenlin
November 21, 2008

The Thrust/Trend Model (T/TM) is on a sell signal for nearly all of the indexes and sectors tracked in the Decision Point Alert Daily Report, but when a rally begins, the T/TM will begin generating buy signals pretty quickly. Nevertheless, because of the extreme market activity we are experiencing, I want to urge those who follow and act on these mechanical signals to apply a little discretionary analysis to new buy signals that emerge.

A new buy signal will be generated when the two thrust components of the T/TM cross up through their moving averages. The PMO (Price Momentum Oscillator) responds more quickly to price movement, and is usually the first component to experience the upside crossover. The PBI (Percent Buy Index) moves more slowly and is designed to keep the T/TM from reacting too quickly. Note on the chart below how it prevented a buy signal at the beginning of November, a most fortunate circumstance.

Unfortunately, the PBI has a finite range (zero to 100). This is normally not a problem, but prices have been beaten down so far that most PBIs are hovering near the low end of the range. Assuming that severe selling pressure continues and PBIs stay near zero, the 32-EMA will continue to drift lower until it intercepts the PBI. At that point it will only require a minor upward twitch of the PBI to generate a buy signal (assuming that the PMO is above its 10-EMA). I would be reluctant to act on such a signal unless there was other confirming evidence. The strongest buy signal is when the PBI moves smartly upward.

While we scrutinize the T/TM on one hand, the more immediate problem is that the selling pressure has not abated in the least, and we wonder where the market may finally find support. The next chart shows that the S&P 500 has broken the major support of the 2002 lows. It is not too late for that support to assert itself, but assuming that the failure is permanent, the next obvious support I see is at 600 and 480. From a fundamental standpoint these targets do not seem unreasonable. Based upon S&P 500 Q3 GAAP earnings (96% of companies reporting) the P/E is 16.3. For the S&P 500 to have an undervalued P/E of 10, prices would have to drop to 514.

Bottom Line: Extreme selling pressures are causing our T/TM to become more sensitive to rallies than we would like. Beware of new buy signals that are not driven by strong price moves.

We rely on our mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your tactics and strategy if conditions change.

BIO: Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.