Monday, July 12, 2010

Follow Through Days Before The 4th Day

It was pointed out to me that IBD declared Wednesday to be a Follow-Through-Day. Since it was only the 2nd day off the bottom this seemed odd to me. I’ve done an extensive series quantifying Follow-Through-Days. IBD’s rules have been fluid over time and sometimes nonsensical based on the evidence. From all appearances they have done very little actual research on their own indicator, and have never shared any verifiable results.

One basic guideline IBD has suggested with Follow-Through-Days is that they should occur between the 4th and 10th day of the beginning of a rally. I examined FTD’s after the 10th day in the February 29, 2008 blog post. At that time I found that FTD’s after day 10 are NOT less reliable as IBD claims. In fact, the small sample was much more reliable.

But what of FTD’s that occur prior to Day 4?

Using the original basic assumptions from the January 14, 2008 study I adjusted the requirement from 4 days (standard) to 2 days (Wednesday’s “FTD”). Below is a quick comparison since 1970. Again, refer to the original basic assumptions for definitions of success and failure of a FTD.

4th Day of Rally Is Earliest Possible FTD – 38 winners and 35 losers.
2nd Day of Rally Is Earliest Possible FTD – 39 winners and 43 losers.

So it appears that allowing FTD’s on day two did identify one additional rally. I looked to see when this additional “success” took place. It was July of 1973. The total rally only lasted 3 weeks. The reason it was “successful” if you entered on the FTD on the 2nd day off the bottom was that the “success” target of a move of twice the size of the distance from the bottom to the FTD was more easily achieved. This “successful” July rally never even went on to break the swing highs of May. Not exactly the kind of winner most traders would be disappointed to miss out on. And while it met the test definition, when looking at a chart it likely isn’t a rally that most traders would even consider successful. Also note that shortening the requirement to 2 days from 4 days triggers 8 more losers.

I don’t agree with many of IBD’s teachings on FTD’s, but in my eyes this particular rule (waiting until day 4) is a very good one. I personally wouldn’t ignore it and am a bit surprised that they did.


veenmr1 said...

In IBD scheme of things the 7/7 FTD was on day 4 of an attempted rally because 7/1 (not 7/6) is considered as day 1. On 7/1 the index traded in high volume, reversed and closed near the top of daily range. There is nothing nonsensical about it. Rather, the "FTD before the 4th day" is a phantom caused by incomplete understanding of IBD's FTD rules.

Rob Hanna said...

Thanks for the input veenmr1.

The "nonsensical rule" that I was referring to was the one mentioned earlier that states days after day 10 are less reliable.

The "wait until the 4th day" makes perfect sense.

As far as claiming the rally began on 7/1, that is a big stretch as far as I'm concerned. Yes, it traded on high volume, but the volume was much larger on the way down than the way up. Closing "near the top of the range" is also quite a stretch. It wasn't even in the top 30% of its daily range, and it closed below the open and it closed down on the day. Further, it closed down again the next day.

If IBD wants to claim the rally started on 7/1 so that they can call a FTD as early as possible in case a rally does emerge, then that's fine. As I've discussed, their rules are fluid.

I'd suggest traders both review my posts related to follow through days and conduct their own research on them rather than accept IBD's claims.

veenmr1 said...

I do not see what is fluid about it. Looking at a daily SP-500 price & volume chart. On 7/1 the index traded in volume higher than average and higher than previous day. The index closed significantly above midpoint of the 7/1 range (H 1033.58 L 1010.91 C 1027.37). This constitutes day one of an attempted rally. No need to complicate matters with intraday volume ("much larger on the way down than the way up") as this plays no role in the IBD prescription. The 7/1 low was not undercut the following day and thus the attempted rally remained intact. If the low had been undercut at any time after 7/1, that would have ended the rally attempt. On day 4 (7/7) a follow-through occurred as per IBD criteria. I do not see the stretch in their train of thought. Does it mean a sustained rally will follow? Of course not. Has there ever been a sustained rally without an FTD? Not according to O'Neil, and if his claim is correct then it seems obviously useful to track FTDs.

On another front, I was not familiar with the IBD claim that "Follow Through Days carry a success rate of between 70%-80%", and the link to it in your earlier article is not working for me. Can you point me to the source?Thank you!

BTW, I find your blog very interesting and useful, despite our disagreement about FTDs.

Rob Hanna said...

V -

We'll have to just agree to disagree about the July 1 "reversal". For my money it simply didn't exhibit the kind of behavior you would like to see on a reversal day.

As far as the 70%-80% stat, it is a shame that link is dead. It was from an old interview, I believe. Anyway, in his book "24 Essential Lessons fo Investment Success", in Lesson #14 on page 81, whne discussing FTDs, ONeil states "About 20% of the time they can give a false buy signal", suggesting about an 80% success rate.

I made the original tests as forgiving as possible and since 1970 the success rate isn't close to this.


Unknown said...

veenmr1 said.."On 7/1 the index traded in volume higher than average and higher than previous day. The index closed significantly above midpoint of the 7/1 range (H 1033.58 L 1010.91 C 1027.37). This constitutes day one of an attempted rally.""

So now a initial rally day doesn't even have to close UP on the day? Wow! Ridiculous. I'd love to see revised FTD stats using that new rule. I bet it's a big loser, statistically.

veenmr1 said...
This comment has been removed by a blog administrator.
veenmr1 said...

Consult William J. O'Neil, How To Make Money in Stocks, 4th edition (2009), pp. 219-222. It shows examples of first days of attempted rallies (aka market bottoms) which had an intraday reversal but closed lower than the preceding day. Ridiculous? The SP-500 rallied almost 9% from the 7/1/2010 intraday low before it began stalling on 7/14.