Why Thursday’s decline wasn’t a surprise
In a
recent article, I made the case for looking at the market’s big
picture. That means going beneath the surface of movement in the major
averages to detect underlying strength and weakness among sectors and
stocks. Thursday’s market decline gave us an excellent example of why such
analyses are important.
Let’s take a look at the market action leading up to Thursday’s drop:
The Dow
(
DIA |
Quote |
Chart |
News |
PowerRating) had made recent bull market highs and was up six days in a
row. That was enough to make the news in the popular media.
Still, there were problems beneath the surface. The Dow had been up for
five weeks in a row, which — as
a different article showed — was not associated with favorable returns going
forward. Even more troubling was the fact that, as the Dow rose, a
decreasing number of stocks made new highs and an increasing number made new
lows.
Here is the table from my personal site, where I track new highs and lows:
| Date | New Highs/Lows
S&P 500 (Large Cap) |
New Highs/Lows
S&P 600 (Small Cap) |
New Highs/Lows
S&P 400 (Mid Cap) |
| 5/10/06 | 40/4 | 40/7 | 20/5 |
| 5/9/06 | 41/5 | 51/3 | 32/3 |
| 5/8/06 | 60/4 | 39/1 | 35/0 |
| 5/5/06 | 74/3 | 80/1 | 46/1 |
What we can see is two things:
* Although the Dow was making multiyear highs, the number of stocks making
new highs in the S&P 500 large caps, the S&P 600 small caps, and the
S&P 400 mid caps was relatively small. At its peak, only 200 of the
1500 issues were making new highs.
* From May 5th through the 10th, that modest number of new highs dwindled
further. By May 10th, only half as many stocks were making new highs as on
May 5th, although the Dow had closed higher.
Now let’s take a look at the number of stocks across all exchanges that made
new 20 day highs and new 20 day lows:
| Date | New 20 Day Highs | New 20 Day Lows |
| 5/10/06 | 963 | 663 |
| 5/9/06 | 1155 | 511 |
| 5/8/06 | 1328 | 418 |
| 5/5/06 | 1559 | 352 |
This was quite a surprise: By the 10th, the Dow was at new highs, but the
ratio of stocks making new highs to new lows was only about 3:2. Clearly
weakness had set into segments of the market even before the market drop on the
11th.
The moral of the story is that most of the popular market indices are
capitalization-weighted. Large moves in a handful of highly weighted
issues can make the entire market look strong or weak. It’s a stock
market, but also a market of stocks. If rising tides aren’t lifting all
boats, we’re much more likely to be grounded when the tide comes in.
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 Development, is due for publication this fall
(Wiley).