by Tom Aspray
The starc bands are a technical tool that I use frequently in my daily column. They help me determine whether a market is in a high-risk buy area (overbought) or a low-risk buy area (oversold). It is important to understand that just because a market is at its starc+ band, the market can still go higher but the probabilities do not favor it.
The regular formula, developed by the late Manning Stoller, adds or subtracts two times the average true range (ATR) from a six-period moving average. In his experience, a market should stay within these bands approximately 92% of the time. If instead you use three times the ATR, then prices should stay within the bands 99% of the time.
These bands are valuable on any stock, ETF, or market average but there is another tool that I use to help me determine when the overall market is overbought or oversold. This is the number of stocks in an average that are above their 50-day moving average. Of course, you can also look at this number relative to a 10- or a 200-day moving average.
This data is widely available on the Web, but last year, I came across a great site Index Indicators, which has an amazing number of free technical indicators. They have data not only on our exchanges but also on Canada, ten different European indices, 11 Asian/Australian markets, as well as Brazil, Mexico, and Argentina. (I have no idea who developed this site but the data seems clean. Of course, I have no financial connection with them).
A word of caution, if your significant other or family becomes aggravated when you spend long hours on research, this site could be a problem as you can easily spend hours, if not days, using it. In this lesson, I want to focus on how I use one small part of the data that they provide.
This chart features the Dow Jones Industrials and overlaid in green is the % of Dow stocks that are above their 50-day moving average. I find this information to be most valuable at market bottoms. The annotations on the charts and the analysis are mine and are not from of the site.
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I am sure everyone remembers the fight over the debt ceiling debacle in the summer of 2011 as stocks started plunging in late July and remained very volatile for the next two months. Many became convinced that another recession was imminent and bearish sentiment was very high.
During the drop in early August, the % fell to zero, and then formed higher highs, line a, at the October lows. The % rose to 13% at the October 4 lows, and a few days later, the A/D indicators turned bullish. I find that combining the A/D analysis with this data can be a powerful tool to identify market bottoms.
In November 2011, stocks dropped sharply the week of Thanksgiving and the % spiked down to 20%, which turned out to be a great buying opportunity. The Dow continued to make new highs, and by the middle of January, the % had reached 100%, which was equal to the October high, line b.
As the Dow was making its high in March, the % was forming a lower high at 90 (line c) and this negative divergence became more pronounced as the Dow made its high on May 1. By the early part of June, the % had plunged to 13 (point d) while the A/D indicators were forming bullish divergences as I noted in Rally Potential That Bears Don’t Expect.
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By early August, the % of stocks was again close to 95% but formed a lower high on September 14 as stocks were peaking. The negative divergence, line e, warned of the correction that lasted until just after the election. At the November 16 low, only 3% of the Dow stocks were above their 50-day MA.
Several times in 2013, the % has reached 93%, line g, but has not made higher highs even though the Dow Industrials have made a series of new highs. A drop below the 60% level will probably signal that a correction is already underway.
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The chart of the S&P shows some similarities to that of the Dow, as well as some differences. The % of stocks also formed a bullish divergence, line a, at the October 2011 lows and then spiked to over 90%, which was a sign of strength. This and the new highs in the NYSE A/D line indicated that the correction in November was a buying opportunity.
The sharp pullbacks in the % to oversold levels when the A/D line is in the early stages of an uptrend are generally good risk/reward buying opportunities.
In February, the % peaked at 88, but by March, it has made a lower high at 82, line b. By the end of April, it dropped further. In late May and early June, it made lower lows, line c, as no bullish divergence was evident in the %. It should be noted that the % did drop to two standard deviations below the mean signaling a very oversold market.
Even though the % of stocks formed sharply lower highs in October 2012, line d, this was not a divergence since the S&P 500 also made lower lows. By the middle of November, as many thought a new bear market was underway, the % dropped to a low of 23%. They ignored the fact that the NYSE A/D line had confirmed the highs, which meant that the intermediate trend was still positive.
So far in 2013, the % peaked in January at 91 and in May was slightly lower at 90, line e. Another new high in the S&P 500 is likely to be accompanied by a lower peak in the % of stocks above their 50-day moving averages. Oftentimes, multiple negative divergences form before a top is completed.
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The Web site also allows you to backtest the % of stocks, as well as all of their other indicators. This table reflects the results of a test on what happened to the S&P 500 for the 15 days after the % dropped below 20. This has happened 41 times in the past two years.
After 15 days, the average gain was 2.53% and the return was positive 77% of the time. It also noted that during the 15 days, the highest return was 4.84%, which occurred at an average of 9.83 days. Its lowest average was -2.41% that occurred 5.29 days after the 20% level was breached.
Their test data suggests that the total return was almost four times better than the buy-and-hold return. They also provide you a listing of all of the signals, which I have not included. Though this test data is interesting, it is not the way I use this indicator.
The Nasdaq 100 was a leading sector in early 2012 as the relative performance analysis indicated it was outperforming the S&P 500. The RS analysis turned negative in September 2012 and has just recently turned around. The % of stocks analysis can often help confirm the relative performance analysis.
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In early August 2011, only 2% of the Nasdaq 100 stocks were above their 50-day MA while in early October the reading was 13% as the % formed significantly higher lows, line a. After surging well above the 80 level in October and early November the 20% level was broken on Black Friday.
From the November lows, the Nasdaq 100 rose 30% by the late March highs. The % of stocks peaked at 93% in early February but only reached 85% at the end of April, line b. A month later, the % had reached quite oversold levels at 10% (circle c.).
There were not any divergences at the September 2012 highs as the % made slightly higher highs, line d. The 20% level was tested in November (circle e), but by the end of January, it was back to 90%. On May 21, only 85% of the Nasdaq 100 stocks were above their 50-day MA, so lower highs, line f, have formed. This negative divergence has not yet been resolved.
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The backtest summary revealed that the % dropped below 20% 40 times in the past two years, and after 15 days, the average return was 4.15% with a positive result in 88% of the time.
The best return occurred after 12.43 days and was 5.59%. The lowest average return of -1.79% occurred after an average of 4.08 days. The total return of 165.84% was over five times better than the passive return. Of course there are many ways to change the backtesting as you can change the market average or indicator, smooth the indicator with a five-, 10-, or 20-day moving average, select the observation period, as well as the level of indicator that will trigger a signal.
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