It’s said that stock market corrections are a healthy part of a bull market rally. But corrections in stocks are also scary for investors. The question on everyone’s mind is whether Tuesday’s sharp sell-off is an opportunity to buy the dip, or time to exit this overextended rally.

There’s one indicator that knows. And here’s a quick summary and crash course of an indicator that’s been 100% accurate over the past 6 months.

Low risk entries for various indexes are identified or triggered by a relative strength indicator called percentR. PercentR is expressed on a scale from 1 – 100. Readings above 80 are considered overbought, readings below 20 oversold.

If you read the ETF Profit Strategy Newsletter from ETFGuide.com, you are very familiar with the term low-risk entry. Low risk entries for various indexes are identified or triggered by a relative strength indicator called percentR. PercentR is expressed on a scale from 1 – 100. Readings above 80 are considered overbought, readings below 20 oversold.

And PercentR rarely lies.

Uncannily Accurate

A picture says more than a thousand words and the chart sheds more light on the value of percentR. As you can tell by the red line, following the W bottom in November (not shown in the chart), percentR spiked above 80 (first yellow circle) around S&P 1,210. This was the initial buy signal.

With two exceptions, percentR remained above 80 ever since. The two dips below 80 (yellow circles) on January 19 and 28 triggered a low-risk entry. Even though investors were worried about riots in Egypt, according to percentR it was time to buy.

This bullish low-risk entry is valid as long as the underlying index (in this case the S&P 500) does not close below that day’s low (white line).  In both instances, the S&P stayed above that low and went on to rally over 5%.

PercentR works with stocks and indexes alike. Similar low-risk entries were identified by the ETF Profit Strategy Newsletter for the Dow Jones, Nasdaq-100 (Nasdaq: QQQQ), overall Nasdaq Composite and the Financial Select Sector SPDR (NYSE: XLF) on January 28. The Russell 2000 was the weakest index and registered its low-risk entry sooner.

Corrections Are Healthy If…

“Corrections are healthy” is one of many ambiguous Wall Street sayings. If you judge the current “bull market” purely on this statement, this market is one sick puppy – there hasn’t been more than a 2.5% correction in nearly a quarter – and needs a serious correction to be jolted back into healthy territory.

Put yourself in a time capsule and zoom back to April 2010 when the major U.S. indexes declined nearly 20% before the promise of QE2 resurrected stocks. There was little conviction then that corrections are healthy. The correction had rattled the investing masses and shaken out many stockholders before the market went on to rally again.

PercentR is the canary in the coalmine that identifies a deeper correction. No significant sell off happens without a failed low-risk entry.

A failed low-risk entry occurs when the indexes close below the low of the day that triggers the low-risk entry (white lines on the chart). The last failed low-risk entry happened in November 2010 when stocks chopped around for a few weeks and ultimately lost about 5%. Another failed low-risk entry flashed a sell signal on August 11 and ushered in a 21 day, 8% sell off.

The Right Tool for the Job

Any craftsman will tell you that there are limitations to any tool, but there’s a tool for each job. percentR is the right tool for the current job.

After a parabolic rally, the job at hand is to distinguish whether pull backs are a buying opportunity or a warning signal. Should you buy the dips or step on the sidelines (or even short the market)?

The ETF Profit Strategy Newsletter consistently monitors percentR as part of measuring the health of the market and sends out special alerts when a low-risk entry (or failed low-risk entry) has been triggered. Considering Tuesday’s sell off, it sure will be valuable to see what percentR has to say in the days to come.

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