Friday, September 22, 2006

New Highs and New Lows: What They Tell Us

When we think of new high and new low data, we normally think of the commonly published 52-week highs and lows. For a short term trader, however, 52-week data is a relatively blunt instrument. Many days, the majority of issues make neither annual highs nor lows. It's when we examine the number of stocks making fresh highs or lows on a shorter time frame that patterns become apparent.

This approach to new highs and lows reflects two principles that have guided my market research:

1) Examine, not just what market indices are doing, but what is happening among the majority of individual stocks. Many times, the market index is less than the sum of its parts.

2) Examine data that other traders aren't looking at. The most common market information is also the most picked over. Investigate measures and time frames that others aren't scouring.

The chart above is an example of these principles in action. The data are taken from the Weblog on my personal site and represent the number of stocks on the NYSE, NASDAQ, and ASE that have made new highs (blue line) or new lows (red line) over the past twenty trading sessions.

Notice two things:

1) Recently, we've been making fewer new highs than we did earlier in the month, despite the large cap indices moving to new price highs;

2) Even as new highs have recently been over 1000, we're also seeing over 500 issues making new monthly lows.

What does it mean when we have a market in which many stocks are making new highs, but also many are making new lows? And is this bullish, bearish, or neutral for stocks going forward? Let's take a look.

Since 2003 (N = 927 trading days), we've had 402 days in which there have been more than 1000 issues making fresh 20-day highs. Ten days later, the S&P 500 Index (SPY) is up by an average of only .06% (217 up, 185 down). Conversely, when we've had fewer than 1000 issues making 20-day highs (N = 525), SPY has been up ten days later by an average of .67% (336 up, 189 down).

In other words, the entire bullish bias of the 2003-2006 period has been eliminated for traders who bought the market when it was strong (i.e., when 1000 or more issues were making fresh 20-day highs).

How about when, as recently, we have more than 1000 new 20-day highs, but also more than 500 new 20-day lows. Since 2003, we've had 62 of those occurrences. Ten days later, SPY has been down on average by -.24% (26 up, 36 down). During 2006, we've had 21 days with more than 1000 new 20-day highs and more than 500 new 20-day lows. Ten days later, SPY has been down by an average of -.47% (11 up, 10 down).

What this suggests is that a market with relatively high new highs *and* relatively high new lows is frequently a market in the process of topping. The new highs reflect the strong stocks that are taking the broad averages to new price highs, but the new lows reflect underlying weak sectors that eventually drag down the broader market.

A rising tide is supposed to lift all boats. If some boats remain underwater, one must question the strength of the tide.

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