Thursday, October 20, 2011

Why I Still Look At FTDs & What Happens When A 1% Drop Follows One

I received a note the other day from a reader who asked why I have so many studies related to Follow Through Days (FTD) on the blog. The reader mentioned that the edges often provided by FTDs are not as compelling as many of my other studies. But one man’s trash is another man’s treasure. And while FTDs may not work as advertised and accurately predict new stock market rallies, they do a very nice job of defining the environment. A FTD tells us the market has undergone a correction. It tells us the market has made a multi-day move off the bottom. And it tells us that strong volume and price action have come into the market. Enthusiasm is picking up.

We understand that the rally is only going to succeed about 40%-50% of the time based on the FTD, but we don’t need to know right away whether it is going to succeed or not to make good use of the information. While many of the past FTD studies on the blog and in the Subscriber Letter have focused on action on and around FTDs and what that might mean for the intermediate-term, it can also be useful to simply put the current day’s action in proper context so that we may better understand what that action may imply over the next few days and weeks. I use context in many other ways and people hardly notice anymore. Studies are always framed by where the market is. Is it above or below the 200ma? At a 20-day high? At a 20-day low? These are all helpful, but recent work has led me to believe that FTDs can be just as useful in defining context, if not more so. So I’ll continue to incorporate them and am optimistic that doing so may uncover some real gems. Anyway…we had a FTD Tuesday and then Wednesday the market sold off strongly. Strong enthusiasm has quickly turned. Let’s look at other instances and what has followed.

The number of trades is a bit low, but the early indications appear to strongly favor another day of selling. Two things really strike me here. 1) There hasn’t been an instance in over 10 years. 2) Run-up/drawdown is heavily skewed in favor of the bears. Overall I find these results compelling enough to take under consideration.


mf said...

What happens when major news comes out!!! I think it might mess this up!

CTPtrader said...

did this study show any effect on whether or not the FTD went on to be successful?

Johan Lindén said...

Thanks for your answer!

I notice that both wednesdays FTD study and this one both failed directly when it comes to drawdown compared to historical data.