After research, there appears to be a bottom indicator based on these values.
The thesis we wanted to test involves this equation:
HOLU Function = (% Below 52 Week High) - (% Above 52 Week Low)
In order to find a bottom, we wish to maximize The HOLU Function (HOLU = High Overextended Low Underextended).
Theory Behind the Equation
The theory is that we want to:
- Maximize the Percentage Below the 52 Week High:
The Greater the Percentage Below the 52 week high, the more likely the market has overextended to the downside, and the bottom may be near.
- Minimize the Percentage Above the 52 Week Low:
The stock market axiom "Buy low, Sell High", appears to be true, and minimizing the percentage above the 52 Week Low is a goal.
So by combining both goals, we have created the HOLU Function above and we wish to maximize the value.
We used data on the S&P 500 From 1950 to March 31, 2008. We looked at the HOLU Function values in relation to the forward one year return on the S&P 500. We averaged the one year forward return on the S&P 500 based on different cutoff values.
In the chart above, if we have a HOLU Value greater than 10%, the average one year forward S&P 500 return is 13.55%, many percentage points above the average one year forward S&P 500 return of 8.51% if the HOLU value is less than or equal to 10%.
When we use a larger cutoff HOLU value of 20%, we get even better results, 18.26% to 8.82%. If we have HOLU Values greater than 30%, we have the largest gain, an average one year forward S&P 500 return of 22.13% (compared to 8.97%).
So the HOLU Function/Equation above appears to generally true. With HOLU Values above 10%, 20% or 30%, we increase our chances of having a good one year forward return if we can assume that history holds. We can use a high HOLU Value above 20% or 30% as a stock market (S&P 500) bottom indicator.
Sample Bottom Days
Here is a sample of the 59 days where the HOLU Value is greater than 30%.
|Date||HOLU||One Year Fwd Return||% Below 52WeekHigh||% Above 52WeekLow|
Please note that October 19, 1987 is Black Monday!
As of March 31, 2008, the S&P 500 is 1322.70. 52 Week high is 1565.15 and 52 Week Low is 1273.37 (Closing Low).
HOLU = (% Below 52 Week High) - (% Above 52 Week Low)
= 15.49% - 3.87%
While we would like HOLU values greater than 30%, 11.62% seems like a decent HOLU value if we look forward one year to the future.
Other Bottom Indicators