Downside acceleration frequently preceeds reflecs bounces

Rob Hanna from Quantifiable Edges performed an excellent research on the short-term effects following downside acceleration. He tested a system than buys SPX at the close after 4 straight down days and the decline during the last (fourth) day is twice bigger than the preceding three. The system sells after x days, where x varies from 1 to 8. The positive expectancy of the system is excellent. Not only the reliability of the trade (% of time being right) is above 70% for all tested cases, but the average profit is more than twice bigger than the average loss. The nature of the trade is strictly short-term.

How come big acceleration in downside momentum often leads such reflex bounces? When the price of an equity reaches certain level of depreciation, it:

1. Attracts value investors.

2. The traders, who shorted it are afraid to give up their nice sized profit and are covering part of their positions.

3. Short-term traders are trying to trigger short-squeeze.

Industry relative strength

Top Industries 1 month performance
Building – Residential Comm 14.5%
Medical – Outpatient HM Care 13.3%
Printing – Commercial 12.1%
Medical – Nursing Home 11.9%
Medical – Hospitals 11.6%
Textile – Apparel 11.3%
Telecoms Services 10.8%
Medical – Dental Supplies 10.8%
Aerospace – Defense Equipment 10.7%
Retail – Discount 10.5%
Bottom Industries 1 month performance
Steel – Producers -20.10%
Coal -16.40%
Mining – Silver -15.70%
Food – Meat Products -13%
REIT – Mortgage Trusts -11.20%

The importance of sector's belonging

  • Do not turn completely bullish or bearish on the whole market. Look at which sectors are bullish or bearish;
  • When you see a move happening in a sector, act upon it immediately, irrespective of the overall market direction. But do not act the same way on other sectors;
  • Confine your trading to prominent stocks in prominent sectors. If you cannot make money out of the leading sectors and stocks, you are not going to make money out of the stock market as a whole;
  • At any time there are only 3-4 groups leading the market.

Jesse Livermore

One of the most important observation of mine about the market is that even the worst stock in top sector will rally more than the best stock in lagging sector. Sector effect is as powerful as blowout earnings or relative strength.

Pradeep Bonde