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