Thursday, February 7, 2008

Is Leadership Breadth Important For A Successful Bottom?

One reason cited by IBD recently for their lack of confidence in the current bottom attempt is the lack of stocks with sound basing formations. While doing a historical study of the number of basing formations seems near impossible to me, one reader suggested looking at new highs. I thought this was a good idea since it should give a reasonable estimate of leadership breadth.

I looked at every Follow Through Day (FTD) identified in Part 1 of the IBD Follow Through Day Study and calculated the percent of New York Stock Exchange stocks that hit new 52 week highs on the day of the FTD. I broke the results down into “Successful” and “Unsuccessful” FTD’s.

This is what I found:

The average percentage of NYSE stocks making new highs on “successful” FTD’s – 2.1%
The average percentage of NYSE stocks making new highs on “unsuccessful” FTD’s – 2.0%

The median percentage of NYSE stocks making new highs on “successful” FTD’s – 1.2%
The median percentage of NYSE stocks making new highs on “unsuccessful” FTD’s – 1.4%

The minimum percentage of NYSE stocks making new highs on “successful” FTD’s – 0.1%
The minimum percentage of NYSE stocks making new highs on “unsuccessful” FTD’s – 0.1%

It appears that leadership breadth has no predictive value when assessing the likelihood that a FTD will succeed or fail.

On January 31st there were 18 new highs out of 3272 issues traded on the NYSE according to my database. This equates to 0.55% and has hereby been deemed a useless fact.

I found the results somewhat surprising as I thought leadership breadth would provide at least some advantage.

I still feel leadership is important to sustain a rally. It appears many times the real bull leaders may not emerge immediately. While the FTD typically comes 4-10 days after the bottom, leadership may take 3 weeks or more to establish itself.

So will this rally attempt succeed? I don’t know. I do know if it fails it won’t be because leadership breadth was too weak.

After all this recent testing of "conventional market wisdom" I’m starting to feel like Adam and Jamie from the Discovery Channel. Myth: Leadership Breadth Is Important At Market Bottoms – BUSTED! Think I could land my own tv show?

4 comments:

Anonymous said...

I pay a lot of attention to breadth when trying to assess a market bottom. However, after a large decline, New Highs make little sense: the small number we usually get is subject to large fluctuations (Poisson statistics). Instead, New Lows have more values. They give the fealing of the fraction of stocks than are unable to form a base and, rather, drop to lewr values during a bottom retest. That it is what I look the most. Compare the new lows during the Jan. 22nd bottom (around 1000, depending on the exchange and the data provider) vs yesterday's (about 100). It is one order of magnitude difference! What do you whant more to call it a succesful retest of a bottom?

Cheers,
Daniel

Rob Hanna said...

Daniel,

Thanks for sharing your thoughts. The new low data certainly is intruiging at this point. I saw some studies back towards the end of January that cited the extreme number of new lows (1000 like you said) had reached levels that normally coincided with intermediate-term market bottoms.

The current new low differential is impressive. I am somewhat hesitant to view it as a divergence yet, though. I'm not certain the market pulled back far enough to call it a "retest". For instance, the SPY low yesterday was about 4.5% above the SPY low in January. I'd find the new low stats more compelling if the SPY and other indices came closer to or dropped below their Jan lows and new lows still contracted.

Whether or not yesterday turns out to be "the retest", the new low data you point out is definitely worth noting and worth following in the days and weeks to come.

Thanks again,
Rob

Anonymous said...

"Quant Mythbusters" - why not ? Be careful of competition though I have heard that some are out of jobs, especially in credit departments...

Keep up the good work !

Anonymous said...

Regading the new low differential, Helene Meisler of TheStreet.com has tracked this for many years. It is certainly intuitive that it has some validity.

Rob, here's a future blog entry idea for you...in talking to some old-time traders from the go-go years in the 60's and volatile years in the 70's, I heard on numerous occasions that a valid indicator to start buying stocks hand over fist is when the number of all stocks trading above their 200 day moving average is 10% or less. If you could do a study on that, I think it would be interesting. Thanks