This mornings deep market transient, in which the SPX fell 1% then climbed back to even, gave us an opportunity to see the internal workings of the market as it separates the losing stocks from the winning stocks. To do this, we can gauge the bullish or bearish bias in a lot of stocks based on their leading or lagging the price recovery. I think this is one of the best technical tells you can get for the health of certain stocks, and today was a good day to apply it.
A graphical comparison is best. To see it graphically, chart the daily movement of the stock in question against its index (SPX in most cases, I use SPY usually) and observe whether the stock fell more or less than the SPX, and when.
Once you can comfortably compare the stock to its index, try to assign the stock to one of these categories:
- It fell faster, and did not fully recover: the stock is strongly bearish biased. You might consider taking profits or going short.
- It fell faster, but fully recovered: Stock is about neutral.
- It fell faster, but overshot the recovery to end with a gain: stock is either neutral or in the process of becoming less bearish. It is volatile too.
- It fell less, and then recovered fully: it is somewhat bullish. Especially if the recovery was faster than the SPX recovery.
- It fell less, but partially recovered, and sluggishly: it is losing some of its bullish bias, and may be becoming neutral. It has low volatility.
- It fell less, and overshot the recovery to end with a gain: stock is bullish or very bullish. Perhaps you should go long this stock now.
I use Lightspeed charting, which I am subscribed to, for the comparison, but you don’t need a powerful intraday charting application to do it. You can get fairly good results on the Google Finance page. Set its window to 1-day, and add SPY to the chart, and it will show a comparison which is proportionate. However, remember you must not compare the stock directly against SPX or SPY - each is compared to its own opening price. For instance, SPY dropped only 1% this morning, but FRE dropped 3.5%. The effect of beta should be ignored when doing this sort of comparison.
Continuing with FRE as an example, even though SPY recovered 100% from its drop today, FRE only recovered about 50%. This tends to give it a bearish outlook.
When working with pairs of stocks, one can use these methods to set up nice pairs trades in which you go short the bearish stock and go long the bullish stock. Then the sudden movements of the market begin to affect your portfolio less, and the market volatility shakes out the losers and props up the winners. In doing so, your trade becomes profitable.
The two charts I placed above show the examples of today’s action in GE and AEM. As you can see, they present evidence that a good trade to consider would be to be short GE and go long AEM. In fact, this was my trade today which I am holding overnight. Anyone initiating this pair trade today at the moment the market returned to even would already be about a percent ahead by the end of the day, and perhaps much more if they had leveraged their play with options. This is one of many, many trades which one might choose based on the movements today.
On a day in which there is a large transient, but the general market ends close to its opening price, the daily winners and losers are about the same stocks as the transient winners and losers. In this case, as a first step you might want to start by choosing your long and short components simply from the list of daily winners and losers. Below are lists of today’s most heavily traded winners and losers, if you’d like to start there. But the list isn’t enough. Charting is important because the leading and lagging behavior can only be observed graphically.
Today was a day to clearly spot money moving out of some stocks and then into other stocks. If you take advantage of what you can learn from market transients to set up winning pairs trades, it could benefit you nicely. Good luck!
[by Skymist]
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