The JSE ALSH index entered a decline phase on 16th April 2010 and recorded a maximum decline of 3,385 points on 25th May 2010, or 11.45% which is technically a correction. This correction has been accompanied by some of the highest volatility in recent memory, spurned on by a Europe debt and currency crises, a program-driven "flash crash" in U.S markets, SEC lawsuits on Goldman Sachs, a ban on short selling by Germany and ratings agency downgrades for Greece and more recently Spain.

A HISTORICAL OPPORTUNITY
As a result this is "not your fathers' 10% correction" with the record levels of volatility and selling pressure leading to this being a historical "Great Trough" coming close in intensity to great corrections such as March 2009 and April 2003. The chart below describes our own quantitative measurement of correction intensity which we have dubbed "The STORM Correction Gauge", which uses a rolling period of daily declining volume compared to accompanying advancing volume to guage "selling pressure":

You can see that the selling pressure for this current correction peaked at a reading of just over 6 on the "Richter scale" (declining volume was six times advancing volume over the rolling window period), slightly less than that witnessed in the troughs of the Great 2008 crash in March 2009 and even more than peak selling witnessed in the October/Nov 2008 bottoms.

Since October 2000 there have only been 12 other occurrences of selling pressure exceeding 5:1, marked in the above chart. As you can see, these periods all marked "Great Troughs". An interesting thing with selling pressure is that it peaks BEFORE an absolute trough forms, with this peak defining the panic selling that flushes the last of the sellers from the system. There is then a very short lull where the market may go up or down or sideways, a so-called "basing" period when everyone mulls over what just happened and then "boom" we have a strong start to a new up-leg as the bargain hunters and smart-money rushes in.

Another superb example of this phenomenon is the Absolute Breadth Index (ABI), invented by Norman Fosback. It is a highly effective measurement of volatility and tracks an exponential moving average of the absolute value of daily advancing shares less declining shares and divided by advancing plus declining shares and shown as a percentage:

ABI = EMA of |ADVANCES - DECLINES|/(ADVANCES + DECLINES)*100

If there is a big difference between advances and declines on a daily basis this index will steadily climb to represent the implied volatility. There is an old saying that high volatility = high opportunity and the ABI Index is a factual representation of this as shown below:


Again, we see that the ABI has climbed beyond the historical high water mark we dub the "Great Trough Line" that has only been breached 13 times in the last 14 years. Each of those times it has been breached led to the formation of a "Great Trough" when the ABI peaked.

SINCE WE ARE WITNESSING HISTORICAL LEVELS OF SELLING PRESSURE AND VOLATILITY IT STANDS TO REASON WE ARE WITNESSING THE FORMATION OF A "GREAT TROUGH". THIS PROVIDES INVESTORS WITH A RARE OPPORTUNITY TO ENTER THE JSE WHILST MAXIMISING THE ODDS OF ABOVE- AVERAGE RETURNS IN THE SHORT TO MEDIUM TERM.

DADDY ARE WE THERE YET? THE FIVE POINT SAFETY CHECK
Our subscribers were alerted to this historical opportunity on 16th April and as the correction has dragged on and on, we have been inundated with "Are we there yet?" emails. Just like when we were all young kids on a long car trip, we know we are headed for an exciting destination but it seems to take forever to get there!

The trick of course is to time the reversal points of these Great Troughs. Whilst we have no doubt that current levels of the JSE provide for good "buying on the dips" opportunity for long term investors, some of our short term traders and medium term investors would obviously only want to get into the JSE when no more downside is likely. We have several quantitative timing models running live at this point to trigger precise alerts to our subscribers, but we also wanted to share with you our Five Point Safety Check system we use to allow you to manage your risk for phased JSE entries during trough formation periods.

The Five Point Safety Check looks at the following things to determine risks as we come out of a trough (small or large ) or a major correction or even a crash:

A. A decline in selling pressure from a peak-selling point
B. A moderation in volatility from a peak-volatility point
C. A sustained improvement in market breadth (advances exceeding declines).
D. A sustained improvement in NET ADVANCING VOLUME
E. A McClellan Oscillator rising or above zero, demonstrating funds flowing into the JSE

Each of the above are measured on a daily basis and scored according to the below chart that gets emailed to our subscribers every night (click for a larger version):


The chart above includes trading till Friday 28th May 2010. As you can see, selling pressure has already peaked and is on the wane. You can see one of our systems, STORM5+ having triggered 3 early-bird entries already. These may not look "great" right now but after 2-3 months they are going to appear as fantastic entries.

Depending on the conditions of each metric we are tracking, up to three ticks are awarded, up to a maximum of 15 across all 5 checks. After 5 ticks we initiate "toe dipping" calls for longer term investors to start snapping up large-cap shares that are showing good value. These may not be good traders entries but for investors, depending on the shares you are targeting, early entries are sometimes better as these large shares invariably have already made quite a move up by the time everyone calls a trough (this stands to reason since the large cap shares are the ones responsible for the buying that creates the trough.)

You can see for chart-B we are just waiting for the ABI to peak to generate a "Great Trough" signal. Chart C shows how breadth is improving, currently up 42.63% from its localised low reading. When this improvement gets above 45 and even reaches 50, we have excellent signals for great troughs, used by our STIX Delta Breadth trough timing system.

Chart D shows net advancing volume (daily up-volume less down-volume). Advancing volume makes the JSE go around. Without sustained advancing volume there can be no sustained advancing JSE. Each days' net volume can whip up and down rather rapidly (green bars) so we slow it down to pick up the trend with a yellow line representing a moving average of the net advancing volume. As you can see when this yellow line is above zero, things on the JSE are progressing along rather nicely.

Finally we require that the McClellan Oscillator be above zero. This measures the health of underlying breadth in the market and is a good representation of funds flowing into or out of the JSE.

WHERE ARE WE NOW?
We can see that we have 7 ticks already which is termed a "Better Odds" entry than the "Toe-dip" entries. For a more conservative approach you may want to wait until at least 8 ticks are showing, perhaps 9 for the ultra-conservative. Just remember, conservatism comes at a price - the longer you wait for the safer signals the more of the initial gains of the trough reversal you may be missing out on. For this reason we advise subscribers to "phase in" their funds with each gain in the number of ticks showing, with increasingly larger portions of funds allocated as the risks decrease.

The answer to the question : "Has the trough formed and reversed?" is no simple one. As always it is countered with a "It depends on your risk" answer. Technically the trough has reversed looking at the JSE today. Could it go lower? It could! But could it keep going higher? Certainly! The more ticks showing the less likely the JSE can go lower but the more likely you have moved further from ground-zero.

You need to view your approaches to the JSE in times like these just as you view driving your car. You have ABS, Seatbelts, Air-bags, Traction Control etc. but does this guarantee you will not have an accident? Does it guarantee you will not get hurt? The answers to both these questions are "no" but that doesn't stop you driving does it? Of course not - but you certainly won't drive unless you have these things turned on! So nothing is ever guaranteed on the stock markets, but what you can do is leverage the best quantitative system available to man and use the clues provided by historical indicators measuring the extremes of stock market psychology to stack the odds in your favour and managing your entry risks.

To read in depth technical research notes on various of the concepts and systems discussed in this paper, or related to it, please try the links shown below:

1. The Absolute Breadth Index - measuring and using volatility to detect peaks and troughs
2. The PowerStocks STORM Gauge - measuring selling pressure and intensity over last 2 decades
3. The PowerStocks STIX Breadth Delta - actuarial trough detection timing system
4. The McClellan Oscillator and Summation Index - the most powerful breadth indicator invented.
5. Anatomy of a correction/crash - what shares to buy just after a large correction *popular*

To see all our quantitative long, medium, short investor and trading timing systems, go visit our TIMING main menu.
 
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