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Technical analysis is rooted in the premise that stock prices ‘trend’ and those patterns of price trends repeat themselves. This assumption is, in some circles, supported by empirical evidence. In other circles, though, it is equally refuted by empirical evidence. Some market analysts don’t subscribe to the notion that price movements are predictable. In fact, they espouse theories focused on the randomness of price movement. These theories, like the Random Walk Hypothesis, are a hopeless framework for taming the markets and achieving superior relative returns. Stock Trends, however, adheres to the religion found in the churches of market technicians – the belief that patterns repeat themselves. The code is written; it only needs to be cracked.
If stocks do trend, what evidence can we provide? Stock Trends is an event driven analysis. It categorizes stocks as either Bullish or Bearish, with six different trend indicators that define every equity issue traded on the NYSE, NASDAQ, NYSE-Amex, and TSX. Each indicator is also coupled with a specific Relative Strength Indicator, a measurement of relative price momentum over a 13-week period. In conjunction with our trend counters we can group specific events – matching trend indicators, Relative Strengths indicators, and time measurements (how many weeks has the trend indicator been in effect).
For instance, if a stock has changed to Weak Bearish ( ) and is outperforming the market by at least 10 per cent (RSI is 110 or greater), what is the historical subsequent price performance for all stocks that matched this criteria? We can further limit the grouping to include stocks at the same share price level or similar in terms of trading volume. With over 7.4-million weekly records in our database these statistical summaries are of interest, to be sure. Indeed, the results of those surveys direct our development of trading systems based on the Stock Trends indicators.
The primary event that the Stock Trends service focuses on is the Bullish Crossover ( ). This event marks the crossover of the secondary trend line above the primary trend line, as defined by our simple 13-week moving average and 40-week moving average trend lines. For many market timing investors this event seems far too lagging, and would not appeal to their timing sensibilities. However, the following survey of our weekly data provides supporting statistics for the Bullish Crossover signal, especially when used in conjunction with the Relative Strength Indicator.
Our weekly records go back to 1980 for U.S. stocks, 1993 for Canadian stocks. We tend to limit our evaluation of the Stock Trends indicators to issues trading above $2 since penny stocks prove to be extremely volatile. For purposes of this survey, only common stocks and income trust units are included, since exchange traded funds are typically based on baskets of instruments.
Given the limits defined above, our data shows us over 63,000 Bullish Crossovers. How significant are these events? A measurement of the change in share price in the period after the moving average crossover tells us whether an investor can count on positive expectations for a favourable trade.
Of the 63,395 events, the majority of stocks (within one standard deviation of their mean returns over the following measurement periods) with Bullish Crossovers had returns ranging as below after the subsequent 13- and 40-week periods:
13-weeks - (-22%) to +28%
40-weeks - (-46%) to +62%
Further, 27 per cent of stocks had gains of 10% and above after 13-weeks, while 14 percent had gains of at least 20%. At the 40-week mark, 39% of stocks had a 10%-plus gain and a 28% had a gain of at least 20%. However, these results are for all Bullish Crossovers in the subset regardless of their concurrent price momentum. What happens when we limit the set of observations to those stocks that were outperforming the market significantly at the time of its Bullish Crossover?
For stocks that were outperforming the market by at least 20% (as an example) - an RSI of 120 or higher – the number of Bullish Crossovers in our weekly data history totals 19,367. Of that subset, the range of returns for the majority of stocks is as follows:
13-weeks - (-31%) to +39%
40-weeks - (-68%) to +92%
Of the Bullish Crossovers with an RSI above 120, 42 per cent had at least a 10% gain 40-weeks later; 34 per cent had at least a 20% gain.
One thing we can learn from these statistics is that price momentum at the time of a Bullish Crossover improves the probability that a stock will generate positive returns. It is one of the reasons Stock Trends focuses on stocks with strong relative price performance. Indeed, investors using our service should always be looking at the Bullish trend events - the Bullish Crossover and Weak Bearish indicators – with respect to the Relative Strength Indicator (RSI).
The positive expectations of these statistics for the subsets described are evidence of broader market forces at work. Every stock, though, represents an individual market. And each stock will have its own specific behaviours that might not correlate to the broader market price movements. It is important to measure the historical performance of an individual stock and compare it to the performance of the broader market.
For instance, Citigroup (NYSE:C) is a recent Bullish Crossover, as are many U.S. financial stocks. How does its historical performance compare to that described above? Does it show a tendency to move in a similar pattern?
If we look at the history of Citigroup's stock after it has had a Stock Trends Bullish Crossover (22 times), its range of 40-week performance is (-31%) to +70% - with a 46% probability of at least a 10 per cent return, and a 41% probability of at least a 20 per cent return. Citigroup’s stock had an RSI of 122 at its Bullish Crossover two weeks ago, so its comparative set measurements can be found if we limit our data survey to Bullish Crossovers stocks with an RSI ranging between 120 and 125. The probability of at least a 10 per cent return 40 weeks after the Bullish Crossover for that set of stocks (numbering 5,230) is 41%, so the expectations for Citigroup’s stock are in line with that of the statistical grouping it currently fits.
Of course, past performance is not a guarantee of future performance, and certainly the market conditions are always distinct. It is hard to know if the discounts written in past price performance fully represent the risks of current or future market conditions. But that is the nature of technical analysis. Investors who espouse its practices – long-term conservative investors as much as trigger-happy technical traders – must model their own trading plans around the probabilities that any particular trade will succeed in providing the returns necessary given the risks involved. Stock Trends hopes to help you achieve good results by highlighting stocks with positive expectations over the intermediate and long-term time horizon.
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) indicator provides evidence of positive expectations as a trade entry signal. This article has a look at some of the statistical returns generated after a Bullish Crossover.
There is a lot to be gained from comparing trends of how individual stocks are doing within a sector, as well as how the sector is performing relative to the broad market.
