Tuesday, October 17, 2017

Bearish Monthly RSI Divergence 100% Accuracy Rate; Occurred at 91.6% of Stock Market Tops

Bearish Monthly RSI Divergence 100% Accuracy Rate; Occurred at 91.6% of Stock Market Tops

Source link:  http://www.thebullbear.com/profiles/blogs/stock-financial-market-crash

Relative Strength Index is one of the most widely recognized and
followed technical indicators. The most common use of RSI is the
identification of divergences:

Developed J. Welles Wilder, the Relative Strength Index (RSI)
is a momentum oscillator that measures the speed and change of
price movements…According to Wilder, divergences signal a
potential reversal point because directional momentum does not
confirm price. A bullish divergence occurs when the underlying
security makes a lower low and RSI forms a higher low. RSI does
not confirm the lower low and this shows strengthening momentum.
A bearish divergence forms when the security records a higher
high and RSI forms a lower high. RSI does not confirm the new
high and this shows weakening momentum. StockCharts.com

The monthly chart of Dow Jones Industrial Average has registered
a bearish divergence at the 2011 and 2012 highs:

I went through the monthly data on INDU going back to 1971. In
100% of occurrences of the signal an average decline of 27.9%
lasting an average period of 10.8 months resulted. Since 1971 in
all 11 occurances of a bearish monthly RSI divergence a
significant decline of at least 16% followed. There was only one
top of significance that did not register this signal and that
occured in 1973. That means that during a forty year period
starting in 1971, 91.6% of all significant tops recorded this
technical signal. That is a period that encompasses two bear
markets and a major bull market as well, which means there is a
firm record of this technical condition resulting in serious bear
markets under a wide range of well identified market conditions.

Here’s a list of the tops regsitering a monthly RSI divergence
and the subsequent percentage decline. Click on the link to see a
chart of the occurrence:

YEAR, PERCENT DECLINE, DURATION OF DIVERGENCE, MONTHS OF
DECLINE

1976, -28%, 5, 19

1980, -21%, 5, 2

1981, -25%, 4, 17

1983, -17%, 6, 8

1987, -41%, 16, 3

1990, -22%, 10, 4

1997, -16%, 7, 3

1998, -16%, 11, 3

2000, -39%, 8, 34

2007, -54%, 4, 18

2012, -??%, 11, ??

  • The average percentage decline is 27.9%
  • The average duration of the bearish divergence (difference in
    the number of months between each price top) is 7.91 months.
  • The average numbers of months of the decline is 10.8
  • The average monthly decline is 3.58%.
  • Removing the outliers of 54% and 16% the average percent
    decline is 26.13%
  • Removing the outliers of a 16 month divergence in 1987 and a 4
    month in 1981, the average duration of divergence is 7.4 months.
  • Removing the outliers of 34 months and 2 months, the average
    length of decline is 7.5 months.

The current bearish monthly divergence took 11 months to develop,
about 3.5 months longer than average. This is the second longest
build to a bearish monthly RSI divergence, the first being the 16
month period leading up to the 1987 top and decline of 41%. The
current market is only 5 weeks off the divergent price top or 38
weeks short of the average and the maxium decline to date is about
9.8% or 18.1% less than the average drop. Altogether this suggests
the probability of considerable more downside in terms of time and
price yet to come in this bear market.

The average percentage retracement following a monthly RSI
divergence is 57.6%.

The nearest Fibonacci retracement percentage level of the prior
wave which it corrected for each signal is shown:

1976-1978
61.8%

1980 100%

1981-1982
78.6%

1983-1984
38.2%

1987 61.8%

1990 50.0%

1997 23.6%

1998 23.6%

2000-2003
38.2%

2007-2009
100%

If this occurance of the Monthly RSI Divergence results in an
average retracement it would entail a decline to Dow 9380 or a
drop of 26% from current levels and it would bottom in December of
2012 at about 9290.

The usefulness of this signal for identifying major tops which
result in an average bear markets of 27% is evident. On its own it
would be a powerful cause for investors to evaluate their market
position. Since it is accompanied by an extensive raft of other
strongly bearish technical indications, it should be taken as an
actionable signal.

While a short term, news driven bounce is likely, it should be
regarded as the last, best chance for investors to exit the market
before a major decline ensues. Front running the announcement of
“easing” by global monetary authorities may work for a period
ranging from a few days to a month or so but it is likely to be
punished severely in the end.

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