Time Frame: Short-Term | Update Schedule: Daily | Source: SentimenTrader
Construction:
The STEM.MR model (Short-Term Extreme Model - Mean Reversion) has the shortest outlook of any of our models. .
It was developed because several of the shorter-term sentiment indicators we follow have displayed a mean-reverting tendency in the past. Meaning, when they go "too far" in one direction, they tend to snap back to their average value. Often when they snap back, it correlates with short-term market turning points.
Depending on market conditions, a signal could last anywhere from an hour to several days. Typically, however, the market makes a decision one way or the other and it is usually clear fairly soon whether the signal will be effective or not.
If the model exceeds the green (lower) band, then we can safely say that short-term sentiment has reached a pessimistic extreme and we should begin to look for upside reversals at any time.
If the model exceeds the upper (red) band, then the optimists may have gotten ahead of themselves and the market may be due for a breather.
Model signals are most effective when going with the trend - for example, giving oversold signals while the larger trend is positive. Even a simple trend filter like the 200-day average can be effective. When it is rising, pay most attention to oversold model signals and less attention to overbought ones.
Also, watching failures is important. When the model suggests overbought conditions, but stocks barely give back any gains and continue higher, then it shows there is impressive buying power, and that normally results in even more price gains in the weeks ahead. Conversely, a weak market that cannot rally off of oversold conditions shows heavy supply, normally resulting in even more weakness ahead.
