Saturday, January 30, 2010

What's logic got to do with it?

So January ended with a pattern called a one-month reversal to the downside. The market made a higher high for its rally and then closed below the previous month's close to theoretically signal that the whatever was driving the market changed intramonth.

Not only that, the month closed below December's low so the reversal aspect is even stronger. And for the Nasdaq, it was a key reversal or key outside-day reversal where the index opened with a small gap up to a new high and closed below December's low. Strict TA tells us that the party should be over.

Then we get some chatter on a professional board that this sort of monthly reversal usually leads to gains down the road. Huh?

From Jason Goepfert: Textbook technical analysis-wise, it's hard to argue. But historically, a key reversal (new 12-month high, then close below the prior month's low) led to positive returns over the next 11 months 76% of the time, 10% avg return, and nearly 3-to-1 reward-to-risk ratio.

Hmm. Damn statistics. But then this:

From David Aronson - For comparison, it would be interesting to look at what the average 11 month returns is for months when there was no key reversal.

Basically, we need to know how much of the gains are due to the natural upside bias in the stock market.

Here's the kicker - we can see a 30% drop in the market back down to the old lows in a short amount of time and then another rip roarin' rally back to new highs - all within 11 months - to keep the statistics alive. Why not? The market did it in 2008 and 2009.

I think I'll step aside for at least the first part of that.


bmbull said...

Please don't wish that sort of whipsaw on us Michael...

paulocuana said...

When I was very young I remember watching an old black and white movie on TV about the Rothschild family. The scene that sticks out in my mind involved one of the Rothschild brothers buying every share of stock he could get his hands on as panic set in as the showdown between the Duke of Wellington and Napoleon approached.
The movie started my fascination with the stock market but also has me focused on sentiment or stock market psychology almost exclusively.
Everyone would love another chance at last March's lows. Is this why the double bottom formation is so common? ;)

Paul O'Cuana

Quick Takes Pro said...

Paul, you got it. What was one a buying opp can become one again. But not when the entire world is focused on it.

Story - a elder trader friend of mine said that when he was a rookie during the Cuban Missile Crisis he naturally was scared to buy stocks. His boss said to buy 'em all because either the crisis passes and stocks will zoom or it won't matter anyway.