Sunday, November 25, 2007

New Highs and Lows in the Stock Market: Mixed Signals

The basket of 40 stocks that I track daily consists of five of the most highly weighted stocks within eight S&P 500 sectors. In that sense, they are among the largest of the large cap issues. As you can see by clicking the chart above, we tend to see a drying up of new 10-day highs prior to intermediate-term market peaks and a drying up of new 10-day lows prior to market bottoms. (Blue line is SPY; pink line is 10-day new highs minus lows among the 40 stocks).

Prior to Friday's rally we saw new price lows in SPY, but new 10-day lows among my basket of stocks actually contracted relative to earlier in the month. That was not the case among stocks overall; rather, it appears to be limited to the large cap issues. For example, we had 1525 new 20-day lows across the three exchanges on November 8th, but 2739 new lows on November 20th.

On Friday we actually finished with more stocks in my basket making new 10-day highs than lows. The past three occasions in which this has happened, we have seen immediate selling take the market lower. Contrast this to what we saw at the August bottom (and in bottoms typically) in which an initial bounce in new highs is followed by further strength and a surge in new highs.

Following the logic of my recent Weblog entry, if we are to see market bottoming from here, we will want to see small caps join the large caps in subsequent strength. Such strength would be reflected in the NYSE TICK and advance-decline statistics. Conversely, if we are to see further weakness and a market capitulation from here, we would want to see those large caps roll over and join the small caps to the downside. This would be reflected in weakening new high/low numbers for my basket of stocks.

At times like these, I like to track the strongest stock sectors (consumer staples, energy) and the weakest ones (financials, materials, consumer discretionary). Market bottoms begin with maximum downside momentum, pulling even the strongest sectors lower; market bottoms end with broad bargain hunting, pulling even the weakest sectors higher. Friday gave us a nice bounce, but it's the follow through that tells us whether we have further to run on the downside.


Tracking Swing Highs and Lows


pruzanb said...

Dr. Steenbarger,

Very good article on the markets today and I liked the article on Seasonal depression. I think I suffer from some level of that every once in a while (live in Palatine, IL). I particularly appreciate and am enjoying your latest book. I have identified with some of the same maladies your example traders suffered from. I have been trading options for the past 18 months or so and began trading in my IRA in September. I had truly amazing returns in that account, mostly due to a bull market and riding the GOOG horse for all she had. When the market turned recently, I had increased my IRA account by more than 30%! But I was over-confident and maybe a bit greedy. I wanted to see the same great returns in a down market. Instead of protecting my profits, I began to play the DIAs and QQQQs, as swing trades. I was playing way too many contracts and was occasionally successful making very large returns. But then it began to swing against me and I lost a lot of money. I ended up giving back most of my earnings in a few short weeks. I finally took stock of my own stupidity and adjusted my trading behavior. For the last few weeks I've been much more defensive and have actually been very happy to preserve my capital on down days and make a small profit on up days. I will continue in this manner to build my self-confidence, but I will never forget the mistakes I made. Profits will be taken or protected. I don't want to be completely risk averse, but I don't think that's my problem. I'm a born gambler, but I have to control the urges to "go for broke" in equity opions. I'm ahead for the year and I'm sure I will continue to grow my account. Okay, just wanted to share. Thanks for your great book.

Bill Pruzan
Palatine, IL

Brett Steenbarger, Ph.D. said...

Thanks, Bill for sharing your trading experience so insightfully. Best of luck in your trading; do stay in touch!