Understanding and Adapting to the Broad Market Environment


The broad market environment is perhaps the single most important factor to consider when selecting a trading or investing strategy for stocks. As with the weather, the broad market environment is subject to change and we need to adapt to current conditions. We should take extra precautions when it is wet and stormy and wear our Bermuda shorts when it is  dry and sunny. Ah, the sun.

Similarly, we should take extra precautions when the market is trending lower with high volatility and take more risk when the market is trending higher with low volatility. Let's look at the shifting environments and consider the current environment.

The chart below shows the S&P 500 with various market environments since August 2017. The index trended higher with low volatility from August to January and hit a new high in January 2018. The environment suddenly changed with a sharp decline in February, but the index largely held the rising 200-day SMA. A volatile consolidation unfolded, but this was a bullish consolidation because it formed after a sharp advance. The index was simply digesting the big gains from the prior months. This consolidation ended with a breakout and return to a low volatility environment in mid May.

The index trended higher with low volatility from mid May to September and hit another new high. The environment suddenly changed again as the index plunged below its 200-day SMA in October and volatility increased. Notice how the 5-day Rate-of-Change exceeded plus/minus 2% on a regular basis. After becoming oversold in late October, the index then consolidated and worked off these oversold conditions. In contrast to the prior consolidation, this was a consolidation after a breakdown and a bearish continuation pattern. Volatility remained high during the consolidation and the index broke down again in December.

Where are we now? Currently, the S&P 500 is in a long-term downtrend and volatility remains high. Stormy weather. Price is below the falling 200-day SMA, the 50-day SMA is below the 200-day SMA and the 1-day Rate-of-Change has exceeded plus/minus 2% thirteen times in the last three months. Also note that the 1-day Rate-of-Change exceeded 2% two of three days this week. Thus, volatility remains above average and the market has yet to settle down.

Bottom Line: the current market environment is both bearish and volatile. We should take extra precautions until this environment improves. Furthermore, the bounce since December 26th is viewed as an oversold bounce within a bigger downtrend.

On Trend on Youtube

The first video talks about the current environment and more. The second video provides a preview of what to watch as we head into 2019. Note that this is NOT a forecast!

On Trend: Assessing the Current Market Environment

  • 5-day RoC Goes Nuts
  • Rubber Band Bounces and Consolidations
  • Forget Relative and Focus on Absolute
  • Treasuries versus Junk and Global Yields
  • Uptrends to Watch Outside the U.S. stock market
  • Analyzing the FAANG stocks (and four others)
  • Click here to Watch

On Trend: 2019 Preview

  • 12 Breadth Indicators to Monitor
  • Volatility has Yet to Spike
  • Defensive Groups Not Immune
  • Treasuries Bid for Big Reversals
  • Monitor Trends and Benchmark Levels
  • Pockets of Strength to Watch in 2019
  • Click here to Watch

- Arthur Hill, CMT

Senior Technical Analyst,

Book: Define the Trend and Trade the Trend
Twitter: Follow @ArthurHill

Arthur Hill
About the author: , CMT, is the Chief Technical Strategist at Focusing predominantly on US equities and ETFs, his systematic approach of identifying trend, finding signals within the trend, and setting key price levels has made him an esteemed market technician. Arthur has written articles for numerous financial publications including Barrons and Stocks & Commodities Magazine. In addition to his Chartered Market Technician (CMT) designation, he holds an MBA from the Cass Business School at City University in London. Learn More
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