Wednesday, January 14, 2015

Keeping an Eye on the Other Side of Your Trade

The recent look at the market suggested weakening breadth in a market dominated by deflation concerns.  Interestingly, stocks have traded lower and we're starting to get into negative territory on the intermediate-term strength measure (above).  That measure takes the number of SPX stocks making fresh 5, 20, and 100-day highs vs. lows and smooths those with a ten-day moving average.  The indicator has room to go on the downside to be sure, but I do make note that we're hitting levels similar to those seen in December even though prices remain higher.  When weak breadth cannot produce fresh price lows, I become more vigilant for the possibility of a bounce higher.

On a related note, I have mentioned in the past the Stock Spotter site of John Ehlers and Ric Way.  They make use of cycle analysis to generate buy and sell signals for individual stocks and ETFs.  Notably, they publish their track record of signals and have done well overall.  I note that, as of yesterday's close, they had 138 buy signals on stocks.  Since late 2013, when I began tracking the service, there have only been five occasions in which we've had 100 or more buy signals.  It's a small sample, to be sure, but all five occasions were higher in SPY five trading sessions later, by an average of 1.59%.

Indeed, when we divide the buy signals by quartiles and look at the highest quartile (most buy signals), we see an average next three-day gain in SPY of  +.33%.  The lowest quartile (least buy signals) yields an average next three-day gain in SPY of +.06%.  This is clearly not how John and Ric designed the service to be used, but I do find it interesting that the broad market has tended to perform best when individual stocks are giving the greatest number of buy signals.

The key point is that, even when you have a strong directional view on a market--especially when you have a strong directional view on a market--it is valuable to avoid confirmation bias and seek out information that runs counter to your conviction.

Further Reading:  Preparing to Win