A pestering concern

I have a problem, it might end up being a small one, but it might not.

Markets are high - which you would think is a great thing, and it is.

But I am a bit wary. I measure how high an Index is by the % of stocks above their 50D average within that Index.

I have always found this to be a really great tool to know whether markets are high or low, because just based on pure simple probability, if most stocks are above their 50D average, it's more probable that a stock is going to fall.

And of course the opposite is true if most stocks are below their 50D average.

As a general rule of thumb, I consider the point where 30% of stocks are above their 50D average as "cheap", and when the same % is at 70%, I consider it to be "expensive". I only add positions when the % is close to 30.

It's served me brilliantly over this year. We can measure the %'s of each Index quite easily, as there are tickers that do this for us. NDFI for Nasdaq, R2FI for my beloved Russell, S5FI for SPX, and MMFI for all stocks listed on the NYSE exchange, handy for a general market perspective.

Notably, the Nasdaq last had an NDFI of 30% at 16,860. It then moved 21% in 84 days before NDFI reached 70%, at which point a 10% correction began. It now sits at 43%, much more reasonable going into a major week of earnings.

The problem? Russell has not followed this correction. In fact it has risen higher, R2FI sits at 79%, slightly under the weeks high of 83%.

I therefore anticipate small caps to correct themselves to a more reasonable level in the short term.

That in itself is fine, I have a large bond position in the portfolio which I am expecting to hedge out the anticipated correction, and I have reduced a part of my small caps exposure with decent partial profits.

But how large of a correction should I anticipate? 

I have a theory. 

If you calculate the % move RTY makes for every 1 point move of R2FI, you can (I think), calculate the markets implied move, similar to options.

For example, if RTY is moving an average of 0.3% for every 1 point move of R2FI, and R2FI is currently 82, to calculate how much the market implies RTY will move down for R2FI to hit 30% :

82 - 30 = 63

0.3 * 63 = 18.9

So we would expect an 18.9% correction.

 In reality, my calculations result in about a 12.7% correction from current levels, equal to RTY at 1980, losing all the recent climb. 

It would be cool if this works, as it could be used to place buy orders at certain approximate levels.

But to lose all the recent rise, would be surprising.