My previous post found that the S&P 500 Index tended to reverse moves when those moves were accompanied by both an expansion of new 20-day highs and new 20-day lows. When more stocks make new lows on an up day or vice versa, the next day tends to retrace the previous move.
During the past three trading sessions in SPY, we've been up significantly but the number of stocks during that time that have shown strong upside momentum, as measured by my Demand/Supply measure (which is given daily in the Trading Psychology Weblog), has declined during that time. When the stocks contradict the market by showing waning momentum in the face of price gains, what happens next?
Since September, 2002 (N = 963 trading days), we have had 139 occasions in which SPY has been up by more than 1.5% over three trading sessions. When those three sessions are accompanied by declining stock momentum (N = 71), the next four days in SPY average a gain of .05% (40 up, 31 down), weaker than the average four-day gain of .17% (532 up, 431 down). When, however, the three strong sessions are accompanied by broadening stock momentum (N = 68), the next four days in SPY average a sizable gain of .64% (43 up, 25 down)--much stronger than average.
Once again we see that what happens among individual stocks truly affects the broad market. When market rises are accompanied by broadening upside momentum, near-term returns have been much better than when rising prices have been contradicted by narrowing momentum.