Friday, January 04, 2008

Stock Market Returns Following Up and Down Days

If you've been following the Twitter posts, you no doubt recognized that we've been seeing expanding 20-day new lows every trading session this week. That, along with the very weak Cumulative TICK Line, has been an excellent indication of weakness to come.

I went back to September, 2002--which is when I first began collating data on 20-day new highs and lows--and found something interesting. Essentially all of the bull market gains in the S&P 500 Index (SPY) have occurred following down days. If a trader waiting for an up day to enter the market, he would have lost money over that entire period!

Ah, but here's the catch. If you bought after a down day when 20-day new highs outnumbered new lows (N = 378), the average return the next day was .13%. If you bought a down day when 20-day new lows outnumbered new highs (N = 214), the average return was only .07%.

Similarly, if you bought after a down day when fewer stocks were making fresh 20-day lows (N = 176), your returns were about twice as large (.17%) as those obtained from buying a down day in which fresh 20-day lows expanded day over day (N = 416; .09%).

In the last few years, it's paid to think about buying the market the day after a decline. But this strategy has been most effective when--unlike the present--we're seeing strength in the 20 day new highs and lows.


What New Highs and Lows Tell Us

When New Lows Swell


Brandon Wilhite said...

Just thought I'd share a few thoughts, that go along with these theme of 'things may still be bad.'

I have to wonder what a possible 1/2 point rate cut at the next FOMC would do. I honestly wonder if it would really be the happy occasion equity traders might think it would be. 1/2 cut will, imo, almost certainly put the USD back into it's free-fall. Also, GBP has been getting routed over the last month or so. JPY hasn't really gotten a whole lot stronger (the one positive I see here), but CHF has been trouncing everyone. My concern is that we are actually still seeing unwinding as far as the carry-trades go, that especially such a large rate-cut would cause another wave of that unwinding, and that this would bleed over into other markets. Sure, the initial reaction might be positive (for equities anyway), but longer-term I'm really not so sure it would buoy the market so much.

It will be interesting to see how the first quarter turns out this year, to say the least :) .


Brett Steenbarger, Ph.D. said...

Those are excellent thoughts re: rate cuts and the unwinding of carry. I think you're right about the concerns re: USD free-fall. Thanks for putting your ideas out there for us--