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I have an unfair advantage when it comes to forecasting the stock market. Unlike 95% of analysts, I use sentiment and Elliott wave analysis to forecast prices which work incredibly well. These two techniques together are a powerful forecasting indicator. Take the current stock market slide for example, regular readers will know that I warned of a potential setback in May.
On 22 May, right at the top of the advance I warned:
“I am concerned because I can’t find any argument to justify buying at these levels and I say this from past experience. When there is no reason to buy, the risk of a severe correction or even a crash is high”
Well, the severe correction I predicted is now underway. On 22 May my sentiment indicator was bearish and the market had completed five waves up.
Note the clear five-wave pattern since the 2012 low on the weekly FTSE 100 chart. The extreme bullish sentiment recorded in May 2013 was accompanied by a turn down in my sentiment indicator. That was a sell signal. This powerful signal was the reason why I became bearish.
This is how it works:
I measure the direction of the stock market with my sentiment indicator. When it is rising the FTSE 100 is likely to rise and when it is declining the FTSE is more likely to decline. According to the statistics measured over the last two years:
When sentiment is up, the FTSE 100 goes up by an average 1.5%
When sentiment is down, the FTSE 100 goes down by an average 0.6%
From a depressed level like the one seen in November 2012 (at the end of wave 2), the FTSE rallied and my sentiment indicator turned bullish on 29 November 2012. From that moment the FTSE trend was up and the rally continued. As the rally extended into April-May, bullish sentiment was on the increase fuelled by rising prices. The effect of rising prices on investors’ mood is well known, the more the market rallies the more bullish investors become and the more investors lose touch with reality. It is a powerful drug that can turn bears into bulls. As the markets continued to climb, bullish sentiment reached an extreme above 400 on my indicator. When the indicator is above 400 (this level was reached on 22 May) we are near the top. The market can continue to push higher for a few days or weeks before turning down, however in this instance on 22 May marked the top. The next step is to wait for the sentiment indicator to turn down to confirm the decline. This occurred on 31 May. What I expect now is the opposite of what we saw during the rally. As prices work their way lower expect bearish sentiment to increase. The next turn will come when my indicator will record an extreme in bearish sentiment.
Thierry Laduguie is Market Strategist at www.bettertrader.co.uk
