Monday, October 31, 2016

What Is Likely To Happen Next For Stocks? A Thought Experiment Suggests A Rapid 5-10% Move (Probably Down)

I have run a few backtests comparing market conditions on the close last week against past data.  On the balance I would have to say that the short term (1-2 weeks) forward expected return is neutral based on the combination of criteria I looked at.

Now that is just going off of past data.  In actuality there seems to be very little chance that the actual returns will be neutral or muted.  The Dow 30 has coiled sideways in a narrow range for 2 months straight, which is very unusual.  It seems obvious that markets are awaiting further information to be generated before moving directionally.

One of the basic ideas related to market movements is that long basing periods represent pent up buying or selling supply and demand.  And so once the range or base is broken, there can be a significant price movement.

So I ran a little though experiment, with the Dow's current tight price action in mind.....

Historically, in the SP500 a typical "leg up" (without a 1 month high to low correction) has lasted about 4.5 months or a little over 90 trading days.  And a typical gain in a leg up has been about 25% for the SP500 average.  So there are obviously some up and some down days even in a trend, but the average close up would be roughly 0.25% for the duration of the trend based on these numbers.  (That includes the down days).  And a typical leg down would show even a little greater magnitude average LOSS per day.

So here we are with the stock averages just moving sideways for 1-2 months.  Let's say there is actually 1-2 months up pent up buying or selling at 0.25% per day.  Just 21 trading days of average 0.25% gain per day is 5.25%.  So what I am getting at here, is that stocks could rapidly move 5-10% once the new trend or reactionary phase begins after this flat, tight base completes.

Now based on price patterns and cycles, I feel the likely outcome will be for a market sell off to occur in the wake of this tight range.  But don't be surprised to see a rapid price change over a few weeks time based upon the pent up supply or demand.


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