Saturday, January 14, 2023

What Does Recent Stock Market Strength Tell Us?


I've found that if you look at enough market indicators, you'll always find reasons to be long or short, and you'll always find reasons to trade.  Far better than following a host of canned indicators is constructing a select number of measures that make sense to you and then learning (and backtesting) their ins and outs.  Chasing multiple rabbits is a great way to wind up with none.

Kudos to the SentimenTrader service, which consistently offers excellent research for equity traders and investors.  They recently highlighted the upward breadth thrust in the market--a situation in which many stocks go from being oversold to overbought in a relatively short period of time--and noted the historical tendency for such moves to continue higher.  A common scenario that explains the pattern is that bears miss the market bottom and then miss the initial thrust higher and so view pullbacks as opportunities to ride the new trend.  That keeps pullbacks relatively modest and helps to create a trending move higher.

One of my favorite indicators comes from data offered by the Stock Charts site and their scans.  Each day I track how many stocks in the NYSE universe closed above and below their upper and lower Bollinger Bands.  When many stocks close above their respective bands, that tells you that there is unusual strength--and it is broad.  

Just in the past week alone, we've had three days in which over 400 stocks closed above their upper bands.  To put this into perspective, since 2019, when I first began archiving these data, there have only been 15 prior occasions of individual days with over 400 stocks closing above their bands.  Such days of strength are rare--and now we're seeing a cluster of such strong days.  Somewhat similar clusters occurred in June and November of 2020; both led to higher prices in the medium term.  Indeed, following the 15 occasions of breadth strength, SPY was higher 11 times, lower 4 times over the next 20 trading sessions.  Average gains were +2.45% vs. +.85% for the remainder of the sample.  Interestingly, following the strong days, there has been no significant directional edge over the following five trading sessions.  It's not unusual to get some consolidation before the trend resumes.

I'm currently working on an intraday breadth thrust model to see how well it anticipates short-term patterns of momentum.  That will require a new and different indicator and perhaps a new way of thinking about breadth.  This could open the door to intraday measures of breadth thrust.  

We hear a lot about traders' "edge" in the markets.  Edges, I've found, are always evolving--and the successful traders are the ones who evolve along with markets.  As an increasing amount of capital is being traded by highly leveraged funds, we're finding a growing number of portfolio managers managing risk on a short-term basis.  This is creating shorter-term patterns of momentum and reversal that can be exploited by nimble traders employing the right tools.  

Further Reading: