Wednesday, December 07, 2016

A Unique Way of Tracking Market Strength and Weakness

Above we see a cumulative running total of the number of NYSE stocks closing above their upper Bollinger Bands minus the number closing below their lower bands.  (Data from the Stock Charts site).  This is an interesting measure, because it tells us how many issues are distinctively strong versus weak.  The slope of the cumulative line is as important as the direction, as it gives us a sense for the breadth of market strength or weakness.  Note the anemic bounce in the cumulative line since the election lows.  This reflects the very mixed breadth of the market rise--some sectors quite strong, others distinctively weak.  Still, the line has been consistently rising, reflecting relatively little weakness among stocks.  For example, the past two days we've seen 95 and 103 stocks close above their respective bands, but only 5 and 9 stocks close below their lower bands.  In general, to get a sustained market decline, we need to see not just a reduction in market strength, but an expansion of weakness.  

The absence of weakness very often is a useful predictor of future market strength.  For example, when the number of stocks below their Bollinger Bands has been in its lowest quartile since 2004 (little weakness), the next 20 days in SPY average a gain of +.95%.  When the number of stocks below their bands has been in their highest quartile (great weakness), the next 20 days have averaged a gain of +.70%.  All other occasions have averaged a 20-day gain of only +.21%.  It's a nice example of how so much in the way of market returns comes from the relative extremes of momentum and value.

Further Reading:  Momentum, Value, and Short-Term Market Movement