Saturday, July 12, 2008

Adapting to Shifts in Market Regimes

We all know that the way to make money in a bull market is to buy dips. And, indeed, that made traders and investors quite a bit of money from 2003 to mid-2007. As this three-year chart from the excellent Decision Point site makes clear, however, we have been lurching from one period of extended numbers of stocks making new 52-week lows to another since that time.

The chart shows the Wilshire 5000 Index (a very broad market proxy) versus the number of NYSE, NASDAQ, and AMEX stocks making new annual lows. In the right hand panel, we can see what that distribution has looked like over the past 21 trading days. We have had day after day of high/expanding new lows with nary a bounce in the market index.

What that tells us is that, as prices move lower, longer time-frame participants are not finding value. What makes for a market bottom is the perception by these participants that the selling has been overdone; that bargains are to be had. When markets move lower and cannot attract buyer interest, they can only do one thing: probe yet lower value regions until equilibrium is attained. That's exactly what we've been seeing over the last month. Traders who have succeeded have been able to separate themselves from the conditioning of the 2003-2007 period and adjust to a different regime of persistent weakness.

This is why I spend a good amount of blog space tracking market indicators, including weekend reviews of data I consider most pertinent to the issue of whether the stock market is strengthening or weakening. I update some of the data most important to my own trading each weekday morning via the Twitter app. These indicators kept me out of trouble during the 2000-2002 bear market, and so far they have filled the same function in this period. The goal is to be neither a bear nor a bull, but to capture the actual buying and selling behaviors of market participants, utilizing data that range in frequency from every 6 seconds (NYSE TICK) to every day; that cover the broad market as well as individual sectors and styles.

It's the only way I know how to stay flexible and adapt to wrenching shifts in market regimes.


Weakness Leading to Weakness