When stocks make highs, should you buy?
In the wake of enthusiasm regarding all-time highs in the Dow Jones
Industrial Average, it’s worth asking the question of whether we can achieve
superior returns by buying periods of elevated prices. The trend follower might
look to capitalize upon such strength; the value investor may shy away from
price highs. Which one makes money in the stock indices?
It turns out that the answer to this question is complex. First let’s
construct an index of NYSE stocks making fresh 52-week highs. We’ll divide the
daily number of new highs by the number of issues traded that day to adjust for
the increase of listings over the years. Going back to 1990 (N = 4196 trading
days), we find that there have been 136 days in which 10% or more of traded
issues have registered fresh 52-week highs. This occurred most recently on
Monday, October 16th.
If we examine returns 40 days following these spikes in new highs, we find
that returns in the S&P 500 Index ($SPX) overall have been subnormal. The
market averaged a gain of only .32% (68 up, 68 down) over a 40-day period, much
worse than the average 40-day gain of 1.47% (2695 up, 1501 down) for the sample
overall.
Let’s, however, break down those results by date. From 1990 through 2003 (N = 87), spikes in new highs led to an average 40-day gain of 1.09% (54 up, 33
down). While this represents no distinct bullish edge compared to simple buy
and hold, neither does it reflect a bearish bias.
Since 2004, however (N = 49), spikes in new highs have led to an average
40-day loss of -1.05% (14 up, 35 down)–quite a bearish bias.
In other words, we’ve been seeing evidence of a regime change. Whereas
buying strength did not hurt investors during previous bull markets, it is
definitely costing them money in this market. Perhaps this time is
different, but given the Fed’s apparent disinclination to cut rates, political
uncertainty going into November, and continued geopolitical tensions on multiple
fronts, I am not betting on it.
And, oh yes, what happens when only half a percent or fewer stocks are making
new highs on a given day (N = 202)? The next 40 days in $SPX average an
eye-popping gain of 4.34% (164 up, 38 down). Those superior returns have
occurred both before and after 2004–no regime change there!
When many stocks have been making new highs, it’s time to bye-bye. And when
nothing is high, it’s been time to buy.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of “The Psychology of Trading”
(Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in
Chicago, he has mentored numerous professional traders and coordinated a
training program for traders. An active trader of the stock indexes, Brett
utilizes statistically-based pattern recognition for intraday trading.
Brett
does not offer commercial services to traders, but maintains an archive of
articles and a trading blog at
www.brettsteenbarger.com and a blog of market
analytics at
www.traderfeed.blogspot.com. His book,
Enhancing Trader Performance, is due for
publication this fall (Wiley).