Friday, March 23, 2007

Using Intraday New Highs And Lows To Anticipate Stock Market Turns

In my post on five principles of short-term trading, I mentioned that strong markets tend to follow through on their moves in the short run, while weaker rises and declines are vulnerable to reversal. I've especially found this principle to be helpful with respect to new highs and new lows among stocks. This is why I track the number of stocks that make fresh 20-day highs and 20-day lows each day in the Trading Psychology Weblog. All other things being equal, a market with expanding new highs will continue to rise; a market with expanding new lows will be vulnerable to further decline.

This makes divergences in the new high/low data particularly informative. For example, when the S&P 500 Index hit its recent low on March 14th, we had 1894 stocks making 20-day lows in the NYSE, ASE, and NASDAQ. On March 5th, however, the number of 20-day lows was 3274. The expansion of new lows on the 5th told me we probably had more downside to go. The shrinking of new lows on the 14th indicated that many stocks were no longer participating on the downside--a pattern that often leads to reversal.

So how about tracking new highs and new lows on an intraday basis?

The chart above for yesterday's market tracks 30-minute new highs minus new lows for the 40 stocks in the 8 S&P sectors that I follow for Dollar Volume Flow. We use closing five-minute prices for the new high/low data (charted in pink) and plot the difference between new highs and lows vs. the S&P 500 Index (SPY; in dark blue). The light blue arrows identify intraday areas where SPY moved higher/lower, but we didn't get a commensurate expansion/contraction in the new highs minus lows. As a whole, these divergences do a nice job of identifying potential meaningful intraday reversal points.

The value of using these 40 stocks is that they are evenly spread across the S&P 500 sectors, which enables us to track situations in which one or more sectors are no longer participating in moves. The stocks are very highly weighted within their sectors, as those are represented by the sector Spyders. Here are the sectors, the Spyder ETFs, and the stocks used for the high/low calculations:

Materials (XLB) - DD, DOW, AA, IP, WY
Industrials (XLI) - GE, UPS, BA, UTX, MMM
Consumer Discretionary (XLY) - CMCSK, TWX, HD, DIS, MCD
Consumer Staples (XLP) - PG, MO, WMT, KO, WAG
Energy (XLE) - XOM, CVX, COP, SLB, OXY
Health Care (XLV) - PFE, JNJ, MRK, LLY, AMGN
Financial (XLF) - C, AIG, BAC, WFC, JPM
Technology (XLK) - MSFT, INTC, IBM, CSCO, VZ

These stocks can be used in a watch list for a screening program (such as Trade Ideas), which can calculate the new highs and lows for you on the fly. My own calculations came from dumping the data from my real-time datafeed to Excel.

Note one other interesting characteristic of the intraday new high/low data: On a range bound day such as yesterday, we'll spend a relatively even amount of time above and below the zero line. When we see consistent more new highs than lows or vice versa, that's when we're likely to have a trend. Similarly, on good breakout moves, we'll see many stocks simultaneously register new highs or lows. That's what happened Wednesday following the Fed announcement: all 40 stocks immediately made fresh 30-min highs and then sustained those. In yesterday's market, we don't see such extreme levels of new highs/lows. Rather, at range extremes, we tend to see a drying up of new highs or lows.

Of course, we could create other groupings of stocks to monitor for those who trade small caps or NASDAQ stocks. We could also create larger, sector-based baskets of stocks for those trading the sector ETFs and track new highs and lows specific to the sectors. For that reason, the intraday new highs and lows are a particularly flexible analytical tool for the short-term trader.