Time Frame: Short-Term | Update Schedule: Daily | Source: SentimenTrader
Construction:
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.
