Monday, March 16, 2009

Tracking the Quality of Stock Market Movement

Today was a great example of a low-quality stock market rally. We opened to the upside, advancing stocks led decliners, and NYSE TICK was strong through the morning, with a positive slope to the Cumulative TICK line.

Two elements, however, made the rise low quality:

1) It was a mixed market - As my Twitter post early in the morning noted, sector participation in the rise was far from uniform. NASDAQ and small cap stocks were underperforming the S&P 500 Index. Industrial stocks were strong in the morning; consumer discretionary shares could not best their opening levels. In a good trend, sectors move in unison. Mixed markets suggest that there is correction occurring as well as strength.

2) The market was inefficient - An efficient market is one that achieves a high degree of price movement for a given unit of buying interest (such as NYSE TICK or advance/decline). An inefficient market is one that struggles to move higher, even as there is net buying pressure. How do we know a market is struggling? If the market needs considerable time simply to break out of its overnight range or to touch R1, then its rise is less efficient than that of a market that hits R1 very early in trade.

Mixed, inefficient markets are low quality markets, and low quality markets are ones that are ripe for reversal. That is why, in my Twitter post at 12:57 CT, I quickly noted the possibility of reversion back into the morning trading range.

A rise is not a rise is not a rise. There is more to markets than the price movements of capitalization-weighted averages. By seeing how various components of markets are moving and by gauging the trajectory of market moves, we can make meaningful inferences as to whether rises are likely to persist or reverse.

As I can (this week is on the road working with traders), I will update Twitter with intraday observations to help illustrate these patterns (free subscription here).