Bad Breadth

neg30qtr

I track some breadth indicators, one of which the number of Russell 3000 stocks that are either up or down 30% in the last quarter (60 trading days to be exact). Above you can see how many are down 30% in the past quarter: it’s the highest we’ve seen in over two years. While I’m not one to predict things unless I’m sure I’ll be right, this demonstrates profound, sustained weakness. It’s not just a narrow spike, but a steady, inexorable climb.

July through November 2014 shows a strong increase in the number of stocks making the Neg30Qtr list.

So what about the positive side of things? Aka the Pos60Qtr meter?

pos30qtr

It’s been worse, but not much worse. At the same time October 2014 was showing a high number of stocks suffering greatly, it also shows there were many stocks doing quite nicely. A wider breadth, in other words.

Let’s look at the difference over time between the Pos30Qtr and Neg30Qtr indicators. Note the blue horizontal line is zero, i.e. there would be equal numbers of +30% / -30% stocks at the zero point.

dif30qtr

This is the most negative the Dif30Qtr indicator has been in two years. In fact, it’s worse than the “taper tantrum” of early 2014, and the plunge of October 2014.

Conclusion: while the market – or more specifically the S&P 500 – is maintaining a relatively narrow price band, the wider universe of stocks is suffering greatly. There is evidence to support this by looking at the S&P 500 Equal-Weight index, which shows considerably more weakness than the market-cap version. In other words, there appears to be a few giant companies propping up the index, which is hiding a weakness in the wider markets.

Sheesh, now I sound like a SeekingAlpha Bear-Monger.

A Target-Poor Environment

Screen Shot 2015-08-19 at 12.51.46 PM

I’ve owned stock in Target Corp. (TGT) for quite awhile.   It’s a long-term play and so I only check it a couple of times per week. I noticed they beat earnings expectations today, and out of curiosity I took a look. The stock had opened  higher than yesterday’s close (about 4.5%) but then fell like a stone. “What a drag,” I thought, “for all those people who bought it at the open in the hopes of it going somewhere”.

That got me wondering, was this ‘failure to launch’ after an earnings beat a result of the current climate, or does this embarrassing dysfunction happen a lot?

I decided to take a look at the period from July 8th until today (08/19/15). I picked that start date because that was when Alcoa announced their earnings report, which is the unofficial start to the quarterly earnings season. I then also selected those time periods for 2013 and 2014.

I selected the current list of Russell 3000 members as my stock universe, with the historical price >$5 and the median 19-day volume greater than 100,000 shares. I looked at all the stocks whose opening price was 5% or greater than the previous day’s close. And I removed any stock that, in the previous 5 days, had their highest close more than 7% above its lowest close. This keeps out the stocks that are thrashing around because of some previous news. It’s not the same thing as selecting only stocks that bumped up because of earnings news. That’s too much time and effort for me – I don’t get paid for writing! So this will have to work as a stand-in.

Under the theory that you might have bought (or shorted) when you detected a stock opening more than 5% above the previous close, I recorded the gain/loss % over the same day, as well as the gain/loss over five days (counting the initial bump as day 1). I then sorted each set of data by the size of the initial bump, and divided them up into vigintiles.

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Ahhh, remember the heady days of 2013? Back then in the hot July and August sun, if your stock popped up over 8% or so, you were off and running. A positive expectancy for sure, especially if you held for five days instead of just one.

Screen Shot 2015-08-19 at 12.25.23 PM

Summer of 2014 wasn’t so hot however, at least from a market perspective. The upper percentages actually were more likely to fail, but over all just a noisy random assortment of returns.Screen Shot 2015-08-19 at 12.25.31 PM

And then there’s 2015. Lower bumps are actually showing a positive return, this time when the close-to-open bump is in the 5.3% to 6.5% range. Interestingly, the extremes are much wider for 2015. Whereas the other years showed a max/min of maybe +/-3% per vigintile, 2015 has some vigintiles exceeding +4 or -4.

Also interesting to note, across all three years, the lowest vigintile (i.e. right around a 5% bump) has a negative expectancy each time. An opportunity to short? Perhaps. I might want to take a detailed look at the 3-6% range in future.

So what does this all mean? Is it a sign that the ‘end times‘ are upon us? Possibly. But more likely, I think it tells us that a simple ‘earnings beat’ is not enough in itself to predict the short-term behavior or stock. Market conditions will affect whether investors will take profits at the earliest opportunity, or if they’re willing to risk a longer-term reward.

Does Lightning Strike Twice?

overnight-gap

One of the things that makes trading individual stocks so risky is “event risk”. Which, to put it bluntly, is when all hell breaks loose because of some news item in the off-hours, causing an overnight gap downward from the close of the previous day to the beginning of the next day.

A stop loss can’t do anything to prevent these overnight gaps. The market doesn’t care if you wanted out at $9.35. If the next day opens at $8, well then that’s what you get.

I was reading a fine blog post by Cesar Alvarez, where he discussed the use of maximum-loss stops with mean reversion systems, and how they usually hurt results. I’ve found the same thing to generally be true, and wondered in my comment whether gaps could be avoided by getting them over with, so to speak. If you incorporate a downward gap as part of your mean reversion strategy, are you able to avoid additional gaps in the future?

In other words, does lightning strike twice?

Let’s go find out!

I picked a year: 2012. Why? Because it’s convenient. Recent but not too recent. Then I selected all of the current Russell 1000 stocks that were in existence at the beginning of 2012. 912 stocks to be exact. And since they’re currently in the Russell 2000 list, they made it to the end of 2012 intact.

During 2012, there were 527 gaps downward that were greater than 5% (as defined by the previous close divided by the current day’s open).

Assuming there were 252 trading days in 2012 (if there weren’t, then my numbers are slightly off but not enough to affect the results), that gives us 229,824 possible moments for a gap.

So on any given day, there was a 0.23% chance of having a gap down of greater than 5%.

Of the stocks that had a >5% gap downward in 2012, there was a 0.63% chance of that happening on any given day (because only 322 stocks accounted for those 527 gaps). Some stocks just behaved themselves in 2012 and avoided downward gaps.

I then looked at all the gaps, and determined if there were any additional gaps subsequent to the first gap. I was surprised by the results.

There was a 1.71% chance of a >5% gap happening in the next 2 days.
There was a 2.47% chance of a >5% gap happening in the next 5 days.
There was a 3.42% chance of a >5% gap happening in the next 10 days.

Gap me once, shame on you. Gap me twice, shame on me.

Mind you, those are still pretty small percentages. We’re only talking 18 instances of a second gap happening in the following 10 days. In 2012, only one ticker had two subsequent gaps following the first one.

But the results, as preliminary as they are, do seem to indicate that downward gaps have a slight tendency to cluster.

Lightning does indeed strike twice.

And you have a 1:280,000 chance of being hit by actual lightning this year.

The Trauma of Mean Reversion

Vital Therapies (VTL)
Vital Therapies (VTL)

I have this mean-reversion trading system I’ve been paper-trading for awhile, and decided to take it live with a few days ago. Vital Therapies (VTL) showed up in my scan, so I set the appropriate limit order, and entered the trade on July 24th. You can see my entry price at the horizontal line above.

It then proceeded to drop and drop and stay dropped. At one point I was down over 20%!

This system has a ‘hard’* stop loss of 30%…yes, 30%. So you don’t bet big chunks of change on any single trade, that’s for sure. It has a high hit rate though, which I’m always fond of. Profit target of 6%, and a maximum hold of 5 days.

I never hit my stop, and then on the day I was to sell it anyway, it popped up 18% from the previous close. I ended up selling at the close of the day at $0.01 less than my profit target.

Talk about a white-knuckle ride. Emotionally these trades are a little tough to handle. You’ve got to basically kiss your 30% goodbye (or more, if there’s a hap) at the start of the trade, and then welcome in back with open arms five days later.

But they are more memorable, like prodigal children, when they come back. Unlike the momentum trades that always behaved themselves.

P.S. VTL is up another 14% intraday as I write. Talk about a stock that moves…BOTH directions.

* “hard” as in triggered intraday with a standing sell order at my broker. A “soft” stop is one that is triggered based on open or close, usually sold the next day.