Tuesday, January 22, 2008

What stocks will benefit the most when the market bounces?

When the market bounces, what do you want to be buying? Contrary to popular belief, the stocks that held up the best during the selloff, do NOT perform the best on the bounce. In fact, it’s quite the opposite. Below are snapshots of the best (Highest RS) and worst (Lowest RS) performing Dow stocks on a few recent waterfall declines. I show the amount they declined prior to the bottom and then how much they bounced during the course of the initial move off the lows (6-8 days). I also show what the Dow did over the same time period.





In every case, the Lowest RS stocks outperformed the Highest RS by an amount close to or greater than the bounce in the Dow! In other words, a spread trade could have achieved returns close to or better than simply going long the index. Careful, though. A spread trade between the best 5 and worst 5 does NOT eliminate the need for market timing. Typically the least favorable stocks will remain so until the market actually turns. When it does turn, though – look to the most beat up stocks to give the best bounces.


Below are the top 5 and bottom 5 Dow stocks since the swing high of December 26, 2007:


6 comments:

mOOm said...

How about long XLF ad XLY and short XLE and XLV?

Rob Hanna said...

My old "HannaETF Money Flow System" - no longer for sale - would attempt trades like that. Generally speaking they worked quite well. You MUST keep in mind though, that the timing is still important. Underperformers will likely underperform until the bounce happens. Also, I'm not sure of your vehicle choices. XLE has dropped over 14% and more than any other of those ETF's since 12/26. That's not necessarily the "right" date to use, but I definitely don't see XLE holding up better than the rest on this recent decline...

Tom L said...

Does this disparity of performance have something to do with the beta, i.e. the ones who don't move much going down won't move much going up either?

Rob Hanna said...

Tom,

I would guess beta may be one of many factors, also including sector rotation, the rubber band effect, short-covering, value buying and more.

Trying to do an attribution analysis on the different factors is beyond me, though. As long as we are able to anticipate where the money is most likely to go, the "why" is secondary, anyway.

MidKnight said...

Very good enlightening and thought provoking post. Thank you.

My best regards,
MK

Anonymous said...

This is a fascinating finding. For the traders here that follow longer term momentum, could you widen the time periods under study in order to demonstrate whether the highest or lowest RS stocks of the last 3, 6, and 12 months are the best "bouncers" in the months following a bottom, possibly as defined by a reversal in bullish percentage charts? Thanks for your work!
BB