3SOF

     "Ask one hundred investors whether this is a bull market or a bear market, and you are likely to find their opinions split evenly down the middle. No one is really certain that the September 2001 low marked the end of the bear market and the start of a new bull market. But, this uncertainty is nothing new. As long as stock exchanges have existed, analysts and investors have always placed heavy emphasis on the difficult task of identifying the primary trend of the Stock market. Everyone's ideal market strategy is, at least in theory, to avoid the ravages of each bear market, and then to move aggressively into stocks after each important market bottom. To further maximize the benefits of a new bull market, time is of the essence. An investor should buy as close to the final low as possible. This is the 'sweet spot' for investors -- the first few months of a new bull market in which so many stocks rise so dramatically. But, theory and reality, especially in the stock market, are often entirely different matters. To bring this theoretical investment strategy to reality, an investor would need a time-tested method of identifying major market bottoms – as opposed to minor market bottoms – and would have to apply this method quickly, to capture as much of the bull market as possible. Traditional methods of spotting major turning points in the market often leave a great deal to be desired. The financial news typically remains negative for months after a new bull market has begun. The economic indicators offer little help since, historically, the economy does not begin to improve until about six to nine months after the stock market has already turned up from its low. Even some widely accepted technical indicators, such as 200-day moving averages or long-term trendlines, can sometimes take several months to identify a major turning point in the market. To spot an important market bottom, almost as it is happening, requires a close examination of the forces of supply and demand – the buying and selling that takes place during the decline to the market low, as well as during the subsequent reversal point.

     Important market bottoms are preceded by, and result from, important market declines. And, important market declines are, for the most part, a study in the extremes of human emotion. The intensity of their emotions can be statistically measured through their purchases and sales. To clarify, as prices initially begin to weaken, investor psychology slowly shifts from complacency to concern, resulting in increased selling and an acceleration of the decline. As prices drop more quickly, and the news becomes more negative, the psychology shifts from concern to fear. Sooner or later, fear turns to panic, driving prices sharply lower, as investors strive to get out of the market at any price. It is this panic stage that drives prices down to extreme discounts – often well below book values – that is needed to set the stage for the next bull market. Thus, if an investor had a method for identifying and measuring panic selling, at least half the job of spotting major market bottoms would be at hand.

      Over the years, a number of market analysts have attempted to define panic selling (often referred to as a selling climax, or capitulation) in terms of extreme activity, such as unusually active volume, a massive number of declining stocks, or a large number of new lows. But, those definitions do not stand up under critical examination, because panic selling must be measured in terms of intensity, rather than just activity. To formulate our definition of panic selling, we reviewed the daily history of both the price changes and the volume of trading for every stock traded on the New York Stock Exchange over a period of 69 years, from 1933 to present. We broke the volume of trading down into two parts – Upside (buyers) Volume and Downside (sellers) Volume. We also compiled the full and fractional dollars of price change for all NYSE-listed stocks that advanced each day (Points Gained), as well as the full and fractional dollars of price change for all NYSE-listed stocks that declined each day (Points Lost). These four daily totals – Upside Volume and Points Gained, Downside Volume and Points Lost – represent the basic components of Demand and Supply, and have been an integral part of the Lowry Analysis since 1938. (Note: an industrious statistician can compile these totals from the NYSE stock tables in each day's Wall Street Journal.)

     In reviewing these numbers, we found that almost all periods of significant market decline in the past 69 years have contained at least one, and usually more than one, day of panic selling in which Downside Volume equaled 90.0% or more of the total of Upside Volume plus Downside Volume, and Points Lost equaled 90.0% or more of the total of Points Gained plus Points Lost. For example, April 3, 2001 qualified as a valid 90% Downside Day. To clarify, the following table was shown in Lowry's Daily Market Trend Analysis Report of April 4, 2001:

DAILY          UPSIDE           DOWNSIDE     POINTS    POINTS   +VOL%   +POINTS%
TOTALS       VOLUME           VOLUME         GAINED     LOST       
   
March 30   964,227,570      508,158,900    1,116       296        65.5           79.0
April 02     383,754,900    1,004,545,180       298       933        27.6           24.2
April 03     146,576,520    1,439,436,850       148      1,447        9.2             9.3

On April 3rd, Downside Volume equaled 90.8% of the sum of Upside plus Downside Volume:
1,439,436,850 / (146,576,520 + 1,439,436,850) x 100 = 90.8%

AND, Points Lost equaled 90.7% of the sum of Points Gained plus Points Lost: 1447 / 148 + 1447) x 100 = 90.7%

     The historical record shows that 90% Downside Days do not usually occur as a single incident on the bottom day of an important market decline, but typically occur on a number of occasions throughout a major decline, often spread apart by as much as thirty trading days. For example, there were seven such days during the 1962 decline, six during 1970, fourteen during the 1973-74 bear market, two before the bottom in 1987, seven throughout the 1990 decline, and three before the lows of 1998. These 90% Downside Days are a key part of an eventual market bottom, since they show that prices are being deeply discounted, perhaps far beyond rational valuations, and that the desire to sell is being exhausted.

But, there is a second key ingredient to every major market bottom. It is essential to recognize that days of panic selling cannot, by themselves, produce a market reversal, any more than simply lowering the sale price on a house will suddenly produce an enthusiastic buyer. As the Law of Supply and Demand would emphasize, it takes strong Demand, not just a reduction in Supply, to cause prices to rise substantially. It does not matter how much prices are discounted; if investors are not attracted to buy, even at deeply depressed levels, sellers will eventually be forced to discount prices further still, until Demand is eventually rejuvenated. Thus, our 69-year record shows that declines containing two or more 90% Downside Days usually persist, on a trend basis, until investors eventually come rushing back in to snap up what they perceive to be the bargains of the decade and, in the process, produce a 90% Upside Day (in which Points Gained equal 90.0% or more of the sum of Points Gained plus Points Lost, and on which Upside Volume equals 90.0% or more of the sum of Upside plus Downside Volume). These two events – panic selling (one or more 90% Downside Days) and panic buying (a 90% Upside Day, or on rare occasions, two back-to-back 80% Upside Days) – produce very powerful probabilities that a major trend reversal has begun, and that the market's Sweet Spot is ready to be savored.

     Not all of these combination patterns – 90% Down and 90% Up – have occurred at major market bottoms. But, by observing the occurrence of 90% Days, investors have
(1) been able to avoid buying too soon in a rapidly declining market, and
(2) been able to identify many major turning points in their very early stages – usually far faster than with other forms of fundamental or technical trend analysis. Before reviewing the historical record, a number of general observations regarding 90% Days might help to clarify some of the finer appraisal points associated with this very valuable reversal indicator:

   1. A single, isolated 90% Downside Day does not, by itself, have any long term trend implications, since they often occur at the end of short term corrections. But, because they show that investors are in a mood to panic, even an isolated 90% Downside Day should be viewed as an important warning that more could follow.
   2. It usually takes time, and significantly lower prices, for investor psychology to reach the panic stage. Therefore, a 90% Downside Day that occurs quickly after a market high is most commonly associated with a short term market correction, although there are some notable exceptions in the record. This is also true for a single 90% Downside Day (not part of a series) that is triggered by a surprise news announcement.
   3. Market declines containing two or more 90% Downside Days often generate a series of additional 90% Downside Days, often spread apart by as much as 30 trading days. Therefore, it should not be assumed that an investor can successfully ride out such a decline without taking defensive measures.
   4. Impressive, big-volume "snap-back" rallies lasting from two to seven days commonly follow quickly after 90% Downside Days, and can be very advantageous for nimble traders. But, as a general rule, longer-term investors should not be in a hurry to buy back into a market containing multiple 90% Downside Days, and should probably view snap-back rallies as opportunities to move to a more defensive position.
   5. On occasion, back-to-back 80% Upside Days (such as August 1 and August 2, 1996) have occurred instead of a single 90% Upside Day to signal the completion of the major reversal pattern. Back-to-back 80% Upside Days are relatively rare except for these reversals from a major market low.
   6. In approximately half the cases in the past 69 years, the 90% Upside Day, or the back-to-back 80% Upside Days, which signaled a major market reversal, occurred within five trading days or less of the market low. There are, however, a few notable exceptions, such as January 2, 1975 or August 2, 1996. As a general rule, the longer it takes for buyers to enthusiastically rush in after the market low, the more investors should look for other confirmatory evidence of a market reversal.
   7. Investors should be wary of upside days on which only one component (Upside Volume or Points Gained) reaches the 90.0% or more level, while the other component falls short of the 90% level. Such rallies are often short-lived.
   8. Back-to-back 90% Upside Days (such as May 31 and June 1, 1988) are a relatively rare development, and have usually been registered near the beginning of important intermediate and longer term trend rallies. "




Paul F. Desmond
Lowry's Reports, Inc.