Tuesday, May 20, 2008

Participation and Intraday Market Reversals

Above we see a five-minute chart of the S&P 500 Index (SPY; blue line) plotted against the number of three-hour new highs minus lows among the stocks in the basket I follow. These are the same stocks that I use to track Technical Strength: five highly weighted issues taken from eight different S&P 500 sectors. As a result, the basket assesses a nice cross-section of stocks within SPY.

The new highs and lows are taken from five-minute closing values over a rolling three-hour lookback period. They give us a keen measure of the degree to which a range of stocks from different sectors are participating in rallies and declines.

Note that new highs minus lows never hit a high level of participation during the morning market rise. At the market peak, for instance, only half of the stocks in the basket were making fresh three-hour highs. Moreover, notice how--as the rally progressed through the morning--new highs minus lows actually peaked ahead of price. This is a common pattern: bullish moves tend to continue when participation is expanding and are more likely to reverse as participation wanes.

An even more subtle pattern was an excellent tell for the afternoon selloff: prior to making the peak price in SPY, five of the basket stocks were actually registering fresh three-hour lows, sending the new highs minus lows into negative territory. These five issues were not limited to a single sector: they were spread across four different sectors. This told us that there was selling underlying the market strength, and it pointed the way to the specific stocks that were leading the weakness. In other words, for some issues, the selloff had already begun.

Finally, note how participation to the downside was much broader than the upside rally had been. All but a handful of shares made three-hour lows in the afternoon. With expanding participation, the decline did not readily reverse, but continued through much of the afternoon.

Traders who watched price only for the broad index or for their particular stock were apt to be surprised by the market reversal. By looking under the hood at the participation in the market rally and subsequent decline, traders could prepare themselves for potential reversal and the subsequent extension of the downside move.


Participation and Reversal Moves

Participation as a Key Market Variable

Participation and Breakout Moves