CORRECTION RISK LEVEL
APPLICABLE TIME FRAME(S):
SHORT-TERM AND INTERMEDIATE-TERM
Each weekday night by 7:00 PM EST
The Correction Risk Level is a quick way to gauge what our indicators and studies are suggesting. The higher the risk, the more likely the market is to decline.
Another way to look at it is in terms of cash. If the Correction Risk Level is 0, then we would be more inclined to keep 0% of our portfolio in cash (i.e. we would be fully invested). But if the Correction Risk Level is 10, then we would be more inclined to keep 100% of our portfolio in cash (i.e. no exposure to stocks).
The Short-term Correction Risk Level is based heavily on the Short-term Indicator Score. The Intermediate-term Correction Risk Level is based heavily on the spread between the Smart Money and Dumb Money Confidence indexes.
In both cases, we take the overriding trend of the market into account. If the indicators are showing excessive amounts of bearish opinion, then the market is more likely to respond favorably to that if we're in a bull market, and the Correction Risk Level would be lower. But if we're in a bear market, then bearish sentiment extremes are less reliable, and the Correction Risk Level would be a bit higher.
We take our studies into account as well. So if the indicators are murky, but we have some very compelling studies suggesting the market should rally, then the Correction Risk Level might be lower than the indicators would suggest.
The default Correction Risk Level is 5, which is where it would be if there is no edge present among our indicators and studies.
We do not suggest using these Correction Risk Levels in any kind of mechanical way. They are meant to help support any existing technical or fundamental research you may be doing.
When the Correction Risk Level is very high, though, we do recommend backing off on long positions or possibly considering short positions (especially during a bear market). For both time frames, a Correction Risk Level below 3 can be considered "low risk" while a level above 7 can be considered "high risk". The more extreme the Correction Risk Level, the more likely the market will respond in a timely manner.
The most likely time for these Correction Risk Levels to fail is during a time of trend transition from a bull to bear market (or bear to bull). That is often good information in itself - if the Correction Risk Level is very high, for example, but prices continue to rise, then that is a heads-up that buyers are very interested, and we will likely see even higher prices going forward.
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