Cabot's Investing Techniques FAQs - Cabot Wealth Network

Cabot’s Investing Techniques FAQs

Q: What does the Cabot Tides Market Timing Indicator tell us?

A: The Cabot Tides Market Timing Indicator is a technical indicator that uses five different market indexes to help us determine the overall intermediate-term direction of the stock market. The indexes are:

  • S&P 500
  • NYSE Composite
  • Nasdaq Composite
  • S&P 600 Small Cap
  • S&P 400 Mid Cap

If at least three of these five indexes are advancing, the market timing signal  is indicating that the market is advancing on an intermediate-term basis. Conversely, if three of the five are declining, the market timing signal indicates that the market is declining.

In order to derive intermediate-term market timing signals, we compare each index to its own 25-day and 50-day moving averages. If the index is standing above the lower of these two moving averages, and that lower moving average is advancing, the index is bullish. Otherwise, it’s safe to assume that the intermediate-term trend for the index is down.

Using this moving average approach for a market timing signal means that you are guaranteed to catch every major market advance and avoid every major market decline. That’s the nature of a moving average. But there is a cost. It is the opportunity lost in the first few weeks of a new advance. It is the small penalty you must pay for getting out of the market quickly when it changes its mind soon after a new buy signal. For example, a new buy signal can quickly turn into a sell signal if the market turns weak enough to drop the index below its lower moving average. If that happens, you should quickly turn defensive again and start thinking about preserving your capital by moving to cash, instead of trying to make big gains in a falling market.

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Q: What do the Cabot Trend Lines tell us?

A: Cabot Trend Lines are our unique way of determining the long-term trend of the stock market. We look at the two most widely followed market indexes—the S&P 500 and the Nasdaq Composite—in relation to their respective 35-week moving averages.

To get a market trend signal, we need to see both indexes close out two straight weeks above (for a buy signal) or below (for a sell signal) their 35-week moving averages. Note that one week isn’t enough—it has to be two weeks in a row. And one index isn’t enough either—it has to be both. We want conclusive evidence, and that’s provided by both indexes moving for two consecutive weeks.

A great example of the accuracy of this market trend signal came in 2009. We sat out most of the 2008 crash (we were 90% in cash in early September of that year, thanks to the Cabot Trend Lines and our other proprietary market trend signal, Cabot Tides), and watched the market sink even deeper in the first quarter of 2009. But then the trend changed—quickly! By late March, our Cabot Tides technical indicator had turned bullish, and Cabot Trend Lines followed less than a month later. You know the rest—the historic 2009 rebound was underway, and our indicators caught the turn perfectly.

Keep in mind that this isn’t meant to be a trading system. After all, we focus on individual stocks. What we’re looking for is to be on the right side of the major trend, and Cabot Trend Lines keeps us there. In fact, the Cabot Trend Lines have consistently been positive for 75% to 90% of major bull and bear markets. Use this indicator along with our intermediate-trend Cabot Tides and you’ll never find yourself heavily investing during a major bear trend, or left on the sidelines in a bull market.

Cabot Trend Lines Signals

This is a chart of the Nasdaq since 2000, with Cabot Trend Lines buy and sell signals. There have been 26 signals during the past 17 years, including a few years with none at all. Our last signal was in April 2016 as the market came out of its mini-bear market in 2015 and early 2016.

It turns out that if you theoretically bought the Nasdaq at every Buy signal during the past 17 years, and went to cash during Sell signals, you’d have doubled the market’s return during that time, up 185% vs. 90% for the Nasdaq. That equates to beating the Nasdaq by 2.5% annually, on average, for 17 full years.

Q: What does the Cabot Emerging Markets Timer tell us?

A: The Cabot Emerging Markets Timer is a trailing market indicator that uses the performance of the MSCI Emerging Markets Index to gauge the trend of emerging market stocks.

The Emerging Markets Timer is considered to be positive when the iShares MSCI Emerging Markets Index (EEM)—which is composed of over emerging markets stocks that trade on major U.S. exchanges including American Depository Receipts (ADRs) as well as direct listed companies—is above the lower of either the 25-day or 50-day moving average.

When the Index falls below both its 25- and 50-day moving averages, the EM Timer turns negative and the Cabot China & Emerging Markets Report adopts a defensive stance.

The EM Timer will not be considered as having turned positive until the level of the Emerging Markets Index once again moves above either the 25- or 50-day moving average, and that average is itself trending upward.

One of Cabot’s three technical indicators for market timing, the Two-Second Indicator is so named because that’s how long it takes to read: just two seconds, every day. This market trend signal measures the number of securities on the NYSE that reach new 52-week lows on any given day. We use the data from the Wall Street Journal, but the same information is readily available in most major newspapers.

Q: What does the Two-Second Indicator tell us?

A: When it comes to market timing, the Two-Second Indicator is most adept at detecting market tops. When the number of daily new lows on the NYSE is greater than 40, and the major indexes are rising to new peaks, look out! This says that, internally, sellers are in control of most stocks, and the indexes are masking this weakness. We call this the Leaky Boat Syndrome—on the surface, things look fine, but in reality, you’re taking on water! It’s the same story when new lows expand to more than 40 just as the indexes come down from their peaks—again, not a good sign.

If there are more than 40 new lows after the indexes are five days or longer off their peaks, however, it’s not as big a deal. In this case, the Two-Second Indicator is simply telling you that the market in entering a correction. Now, you will still want to exercise caution, as the correction could be deep, but the chances that the market is entering a real bear market at that point are slim.

When new 52-week lows are less than 40, that’s a sign of a healthy, robust market. This says that the buyers are firmly in control of most stocks. As a market trend signal, the Two-Second Indicator is simple, but we’ve learned that the simplest indicators are often the best, and this one certainly fits the bill.

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Originally published 2016.


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