Context is King: Market State
We've covered the signals The Stock Archeologist digs up in Default Mode and Custom Mode. Sharp patterns, potential reversals, momentum triggers – interesting stuff. But here's the dose of reality: a signal doesn't exist in a vacuum. Trading signals without context is how amateurs blow up accounts.
Today's focus: Market State. This is non-negotiable context. It’s the prevailing wind. Are you sailing with it, or fighting against it? The Archeologist figures this out so you don’t have to guess.
No. Absolutely not. Think of the overall market as the tide. A fantastic individual stock setup (a signal) is like having a speedboat. In a rising tide (bull market), that speedboat flies. In a falling tide (bear market), even the best speedboat struggles, and might even get dragged backward.
Ignoring the market state is ignoring the dominant force acting on most stocks. It directly impacts probabilities. A bullish signal has a much higher chance of working out when the overall market is bullish. The same signal hitting in a nasty bear market? The odds are stacked against you. Understanding the Market State helps you filter signals, manage risk, and frankly, stay out of trouble when conditions are hostile.
No secret sauce here, just common sense applied systematically. The Archeologist uses the SPY ETF as a proxy for the overall US market. It’s the benchmark.
We look at where SPY is trading relative to two key Simple Moving Averages (SMAs) – basically, the average closing price over a specific period:
Short-Term State: Based on the 50-day SMA. Is the market currently trading above or below its average price over the last ~2 months? This gives us a feel for the immediate trend.
Long-Term State: Based on the 200-day SMA. This is the big one. Where does the market stand relative to its average price over the last ~10 months? This defines the major, long-term trend.
The program calculates how far SPY is from these averages. Based on certain thresholds (e.g., significantly above, significantly below, or roughly in line), it determines the state.
For both Short-Term and Long-Term, the state can be one of three:
Bull: Market is significantly above its relevant SMA. Generally positive conditions. Tailwinds.
Bear: Market is significantly below its relevant SMA. Generally negative conditions. Headwinds.
Neutral (or Sideways): Market is trading relatively close to its relevant SMA. No strong directional push. Choppy conditions likely.
The daily feed you get combines these. So you'll see things like:
Short: Bull / Long: Bull: Ideal scenario. Both short and long-term trends are positive. Strongest tailwind.
Short: Bear / Long: Bull: A pullback within a longer uptrend. Caution warranted, potential dip-buying opportunity if the signal is strong, but risk is higher.
Short: Bull / Long: Bear: A rally within a longer downtrend. Often suspect (bear market rally). High risk for longs.
Short: Bear / Long: Bear: Double Bear. Maximum headwind. Bullish signals are very low probability here. Stay defensive.
Neutral combinations: Indicate chop or transition. Requires extra care.
This is crucial. The Confidence Score you see attached to signals in the feed isn't just based on the historical performance of that signal in isolation. The Archeologist adjusts that confidence based on the current Market State.
Alignment Boost: If a bullish signal appears when the Market State is Bullish (especially Double Bull), the confidence score gets a significant boost. The environment supports the signal.
Conflict Penalty: If a bullish signal appears when the Market State is Bearish (especially Double Bear), the confidence score gets penalized, often heavily. The environment opposes the signal.
Beta Consideration: The program even considers the stock's Beta (its sensitivity to overall market moves). High-beta stocks trying to rally in a bear market get penalized more than low-beta stocks. It’s about realistic probabilities.
Simple: Check the Market State provided in the daily feed before you even think about acting on a signal.
Is it Double Bull? Signals have the best chance.
Is it Double Bear? Maybe sit on your hands, or look for short setups if that's your game (though the Default Mode focuses on longs).
Is it mixed? Be selective. Prioritize signals with higher confidence scores. Maybe reduce position size.
Don't fight the tape unnecessarily. Understanding the Market State is a fundamental piece of risk management and improving your odds. It’s the context that separates informed speculation from blind gambling.
That’s it for Market State. Internalize it. Use it.
Caesar