As noted in the recent tweet, we had a strong downside momentum day on Monday, with Demand closing at 15 and Supply at 214. The general pattern following such downside momentum days is a bounce one day later followed by subsequent weakness, although this pattern is affected by larger-term market regimes.

Given the significant expansion in the number of stocks registering fresh 20-day lows, I went back to October, 2002 (when I first began archiving the 20-day high/low data) and examined what happens in the S&P 500 Index (SPY) after 20-day new lows make a 20-day new high. The next day, SPY averages a gain of .18% (91 occasions up, 59 down), versus no change for the rest of the sample (818 up, 712 down). Five days after a surge in 20-day lows, SPY averages a gain of .47% (88 up, 62 down), versus .02% for the remainder of the sample (836 up, 694 down).

It’s thus not unusual to get a bounce following significant market weakness. I will be watching to see how we trade relative to yesterday’s pivot level, as well as the usual sentiment gauges of NYSE TICK and volume transacted at bid/offer, to gauge the likelihood of sustaining a bounce on the day today. Alternatively, inability to sustain buying sentiment below the pivot would sustain the downtrend.

10:17 AM CT – I added the above chart of the NYSE TICK with a green 20-minute moving average to show how sentiment has weakened during the trading day, with more stocks transacting on downticks than upticks. Noticing that shift was key to anticipating the move below the overnight low. Should we continue with bearish sentiment, the next target would be S1. The fact that it’s taken us a while to even approach S1 suggests to me, however, that we could see more of a range environment, trading back into the overnight range, in advance of the Fed announcement and Wednesday’s numbers. I’m watching TICK closely to handicap that scenario (but not become wedded to it!)

Above we see the five-day average volume (top chart) for the S&P 500 Index (SPY) and the five-day average trading range (bottom chart). One theme stressed on this blog is the importance of trading volume, largely because of its correlation with volatility.

As stocks have moved higher since the March lows, volume has steadily declined and so has the average high-low trading range. Stocks now provide almost 1/3 the expected range as earlier in the year.

This is why I find it crucial to adjust profit targets for volatility. (Note: SPY profit targets are posted every morning before the market open via Twitter; follow here or check the last five tweets on the blog page). Without such adjustment, we inevitably expect too much out of a trade when volatility comes out of the market, leaving us open to frequent and frustrating reversals.
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One of the areas I’ve spent a fair amount of time on is news-related sentiment.  How stocks react to overtly positive or negative news, and what impact that tends to have on the broader market, is a consistent source of good information.

The new blog Sentiment News by the good folks at RavenPack (don’t ask what it costs, it’s not priced for individuals) highlights a study by Macquarie Research highlighting stock performance surrounding positive and negative news.

Some highlights:

• Investors are more likely to react adversely to negative news sentiment than to react favorably to positive news sentiment.
• Negative news sentiment is a stronger leading indicator of future underperformance than positive sentiment is for future outperformance.
• Stocks tend to be underperforming prior to a negative news announcement.
• Stocks tend to rebound after about five days {after negative news}.
• There is no short-term reversal after positive news events.

All of these confirm what I’ve found as well, so they are useful rules of thumb if trading individual stocks or even sectors that are greatly impacted by bellwether stocks.

Source:

How Does The Market React To News?

News Sentiment, June 17, 2009