Friday, March 14, 2014

Riding Trends Through Countertrend Trading

I recently posted a measure of intermediate-term market strength as well as moving average crossovers.  Above is a short-term measure of breadth specific to S&P 500 stocks that I have found helpful.  As with the intermediate measure, the raw data are from the Index Indicators site--shoutout to Mo Shaarani for a very useful site.  I archive the data and construct the indicator and chart it within Excel.  

This short-term breadth measure consists of a daily average of the percentage of SPX shares trading above their 3-day moving averages, their 5-day moving averages, their 10-day moving averages, and their 20-day moving averages.  So when the index approaches 100, the vast majority of shares are in uptrends over all of those short-term timeframes; when it approaches 0, the vast majority of shares are in short-term downtrends. 

Interestingly, when the breadth index closes below 30, since 2013 the next five-day gain in SPY has been 1.25%, almost four times the average gain for the remainder of occasions (.33%).  It's a great example of how markets that look and feel the worst--and that trigger the most stops for long positions--end up having the best near-term returns. 

Imagine short-term cycles superimposed on a long-term upward trend:  that is the market we've enjoyed for the last couple of years or so.  In such a market, it makes a lot of sense to be a trend follower--but to enter long positions in a countertrend mode.  

Further Reading:  Breadth as a Market Tool