Friday, April 04, 2008

One-Sided Days in the Stock Market

I've heard from a number of intraday traders who have been performing quite poorly during very strong or very weak market days. Interestingly, most of them have also been underperforming overall. My take on that is that the stock market has been featuring more one-sided days, in which stocks generally trend higher or lower intraday--a kind of herd effect. We would expect intraday traders who fade early market moves to suffer on these one-sided days, and we would expect their overall performance to suffer if these one-sided days are more frequent now than in the past.

So let's do what too few traders do and actually look at market data.

I examined the number of days in which advancing stocks outnumbered declining issues by more than 3:1 and those days in which decliners led advancers by more than 3:1 across all NYSE issues. These are relatively one-sided days: the vast majority of issues are either rising or declining. From 2002 through the end of 2006 (N = 1259 trading days), we had 101 such one-sided days. That's a little less than 9% of all occasions.

Since 2007 (N = 315 trading days), we've had 74 one-sided days. That's almost 25% of the total. In other words, since 2007, the proportion of one-sided days has increased dramatically.

The reason for this, I believe, is that large money managers (such as hedge funds) are increasingly managing their portfolios on an intraday basis. When they see risk aversion themes kicking into markets, they dump stocks; when they see risk-seeking, they snap up shares. This creates intraday herd effects that don't necessarily carry over to the next day's trade.

What that means is that skilled intraday traders need to distinguish between early strength and weakness that represents movements of the herd and early strength and weakness that is part of normal, random drift (and hence likely to reverse). Tracking risk-aversion and risk-seeking themes in fixed income and currency markets; tracking trader sentiment with tools such as NYSE TICK; and tracking intraday market breadth (and its trend) are useful in this regard.


NYSE TICK and Intraday Trend

Intraday Trend and Sentiment