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When Stocks Makes Highs, Should You Buy? Print E-mail
Tutorials | Articles | Written by Brett N. Steenbarger |

Note: A version of this article appeared on 10/20/06 on the Trading Markets site.

In the wake of enthusiasm regarding all-time highs in the Dow Jones Industrial Average, it's worth asking the question of whether we can achieve superior returns by buying periods of elevated prices. The trend follower might look to capitalize upon such strength; the value investor may shy away from price highs. Which one makes money in the stock indices?

It turns out that the answer to this question is complex. First let's construct an index of NYSE stocks making fresh 52-week highs. We'll divide the daily number of new highs by the number of issues traded that day to adjust for the increase of listings over the years. Going back to 1990 (N = 4196 trading days), we find that there have been 136 days in which 10% or more of traded issues have registered fresh 52-week highs. This occurred most recently on Monday, October 16th.

If we examine returns 40 days following these spikes in new highs, we find that returns in the S&P 500 Index ($SPX) overall have been subnormal. The market averaged a gain of only .32% (68 up, 68 down) over a 40-day period, much worse than the average 40-day gain of 1.47% (2695 up, 1501 down) for the sample overall.

Let's, however, break down those results by date. From 1990 through 2003 (N = 87), spikes in new highs led to an average 40-day gain of 1.09% (54 up, 33 down). While this represents no distinct bullish edge compared to simple buy and hold, neither does it reflect a bearish bias.

Since 2004, however (N = 49), spikes in new highs have led to an average 40-day loss of -1.05% (14 up, 35 down) - quite a bearish bias.

In other words, we've been seeing evidence of a regime change. Whereas buying strength did not hurt investors during previous bull markets, it is definitely costing them money in this market. Perhaps this time is different, but given the Fed's apparent disinclination to cut rates, political uncertainty going into November, and continued geopolitical tensions on multiple fronts, I am not betting on it.

And, oh yes, what happens when only half a percent or fewer stocks are making new highs on a given day (N = 202)? The next 40 days in $SPX average an eye-popping gain of 4.34% (164 up, 38 down). Those superior returns have occurred both before and after 2004 - no regime change there!

When many stocks have been making new highs, it's time to bye-bye. And when nothing is high, it's been time to buy.

Brett N. Steenbarger, Ph.D.

www.brettsteenbarger.com