Sunday, October 22, 2006

When New Lows Swell, Is It Time To Sell?

My last post examined relative new 20-day highs and found an interesting momentum-based pattern in the data from 2004 to the present. In this post, we will look at relative 20-day new lows and see if there might be similar tradable patterns.

As before, relative new lows reflect the number of stocks making fresh 20-day lows minus the average number of new 20-day lows over the prior 20 sessions. When the relative new lows are highly positive, it means that many more issues are making new lows than over the previous 20 sessions. A highly negative reading indicates that new lows have contracted greatly from their recent average.

Since 2004 (N = 697 trading days), we have had 52 occasions in which new 20-day lows have exceeded their 20-day average by 750 or more. Five days later, the S&P 500 Index (SPY) was up by an average of .52% (35 up, 17 down). That is much stronger than the average five-day gain of .14% (391 up, 306 down) for the entire sample.

In other words, when new lows have expanded sharply, returns have been bullish over the subsequent five trading sessions. When new lows swell, it’s not been time to sell.

How about when the number of new lows contracts greatly?

Since 2004, we’ve had 60 occasions in which new lows have fallen short of their average by 600 issues or more. Five days later, SPY is up on average by .19% (36 up, 24 down), modestly stronger than the average five-day performance. Interestingly, however, when we look 9 days out, SPY was up on average by .54% (43 up, 17 down). That is much stronger than the average 9-day change of .26% (408 up, 289 down) for the sample overall. In short, it has paid to buy and hold after new lows contract sharply.

These results point to two bullish edges: 1) a reversal effect after new lows expand greatly; and 2) a continuation effect after new lows sharply contract. When new lows have neither expanded nor contracted significantly (i.e., have been within 200 issues of their 20-day moving averages; N = 291), returns in SPY have been subnormal from 5-9 days out.

Once again, this points to strong momentum and lack of momentum as important variables in short-term market returns. The 20-day new high/new low data each day are available from the Trading Psychology Weblog.


Deborah said...

Personally, when new lows swell, I research the company and look for a valid reason for the new.

Too often people seem to be engaging in panic or emotional selling. I really don't get it.

Seriously, I've seen stocks making a 20% return on share price, in an enormous growth phase being sold off because commodity prices have gone down. And when you check the annuals and what prices the commodities were at to make that 20%, well, maybe they might only make 18% next quarter, without growth.

Anyway, I find the best buy deals looking at new lows. That doesn't mean all new lows are a deal. I've also seen people buying new lows where I've seen insiders continuing to sell of millions upon million of shares. I forget the ticker, but I saw one where the stock price had dropped to about 1/6th and the CEO was continuing to sell off. I was so intrigued, I went back and quickly added up pages and pages of his selling and I got tired of adding at over $300,000,000. And people were still buying. A week later, it was down to half again.

So far I've won on 33/35 stock picks, and for the 1 of the two I lost on, I was simply premature in decided to cut losses, it took off the next day.

Brett Steenbarger, Ph.D. said...

Hi Deborah,

Congratulations on your success. I think your idea re: looking more in depth at companies at new lows makes a lot of sense. Some of the best bargains can be found when good companies get swept into selling panics along with the bad companies.