Securities Research Services

Monday, February 04, 2008

SRS Risk Assessment Meter

No one knows what the market will do tomorrow but it is clear that some days risk of failure is higher than other days. We have examined the charts and have now developed a way to quantify risk using a simple set of objective criteria. Note, it is important to keep criteria simple, otherwise interpretation of the factors may be too subjective.

We will use the SPY (S&P 500) as our benchmark.

Criteria are as follows:

1. Long term trend direction
2. Near term trend direction
3. Distance from 40- and 50-week EMA
4. Distance from weekly Bollinger Band support
5. Near term sentiment readings

From the results of these criteria we can then establish objectively A) whether we should be long or short, and B) how high risk of failure is.

From today, we plan to post the daily risk level and whether the long or the short side offers the best risk:reward.

The SRS Risk Assessment Meter will help us to determine whether it is best to be:

1. Heavy long
2. Light long
3. Stay in cash
4. Light short
5. Heavy short

Today's SRS Risk Assessment Meter Results


Long term, the market is in a confirmed downtrend. However, the near term trend is now up. Following the failure of Wednesday's sell signal the probabilities are now high that the price will return to the 40- and 50-week moving averages, giving the near term trend a price target of $143-$143.50.

Near term the price is currently extended a large distance from lower weekly Bollinger Band support without a pullback. Likewise, near term sentiment readings have moved into dangerous, overly bullish territory.


Over the next few weeks the likelihood that prices will regress back to their, as measured by the 40- and 50-week averages is high, which means that traders should have a long side bias here. Before new long positions can be safely taken, however, prices need to pull back to work off near term over bought conditions.

Two potential scenarios could unfold from here, prices may extend their run over coming days without a pullback, or prices could pull back in an orderly fashion.

If prices continue to extend, it is best to stay in cash as risk will remain extremely high. If, however, prices pull back starting early this week, we would look for a SPY pullback target of $133-$134. This would offer traders a chance to go lightly long for the run back to the 50-week average at $143.50.

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