One reason that chartists find their craft so appealing is the optics. They can tell a great deal about a market or security merely by looking at the chart. At times, however, they can get into trouble by making assumptions about the optics that are not borne out by reality. In other words, looks can be deceiving.
Take yesterday’s dramatic reversal lower in the stock market, for example. Specifically, the NASDAQ was well into new all-time high ground at one point during the day. However, by the end of the day, the index has lost all of its gains and then some, closing well into negative territory. Upon a glance at the day’s bar or candlestick on its chart, one might understandably be concerned about residual negative consequences stemming from the day’s action. Such concern over the event may be reinforced by the popularity of ominous-sounding descriptors like “key reversal” or “bearish engulfing”, etc. The problem is, despite the widespread acceptance of such terms, historical evidence often fails to back up their reputations.
That indeed may be the case with yesterday’s action in the NASDAQ. At least we did do some historical research in attempting to ascertain whether or not the reversal was indeed a red flag – or significant in any respect. As such, we tried to pinpoint historical reversals in the NASDAQ occurring under similar conditions as yesterday. Specifically, we looked for all days since 1992 meeting the following criteria:
1. The NASDAQ trades at least 0.5% higher intraday, and
2. It trades above its 52-Week High Close, and
3. It reverses to close lower by at least 0.5%.
As it turns out, yesterday was the 43rd day in the past 25 years meeting the above criteria.
As one can probably glean from glancing at the chart, several of those events occurred if at inauspicious points – specifically, cyclical or major intermediate-term tops. That said, one may not be able to tell from the chart that median returns following the events were actually better over the following 2 weeks to 2 months than the average random day.
So, a historical look at these types of reversals yields some fodder for both bulls and bears. Perhaps most importantly, though, it fails to confirm the widely accepted notion that yesterday’s type of action is a reliable predictor of further trouble in the market, despite the ugly candlestick and its scary-sounding descriptions.
The PowerShares QQQ ETF (NASDAQ:QQQ) fell $0.19 (-0.14%) in premarket trading Friday. Year-to-date, QQQ has gained 11.44%, versus a 5.33% rise in the benchmark S&P 500 index during the same period.
Want to see the “deep dive” version of this post, including specific dates, future returns and which of the reversals were truly cause for concern? Check out our new “all-access” site, The Lyons Share, where members get our full research reports – as well as our complete macro market analysis EVERY DAY. If you find the original research we share here helpful and enjoyable, we think you’ll get a ton of value from The Lyons Share.
Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
This article is brought to you courtesy of Dana Lyons, JLFMI and My401kPro.