(appeared in October '04 issue of CANSLIM.

net News)
Buyi ng Qual i ty Stocks i n Today's Market: Pul l backs Versus 21-Day New
Hi ghs and 21-Day New Lows
Ive written here about cycles in the market, i.e., market patterns that appear often enough to
be judged statistically significant. For example, the Automotive, Health Services, and
Aerospace Industry Groups were shown last month to provide the best performance of the
31 groups in the September-to-December time frame over the last four years. Here, I want
to contrast three chart patterns that are routinely used to enter long positions in short-term
trades. I think youll be surprised at the results.
Larry Connors and Conor Sen wrote an important book detailing the importance of chart
patterns, How Markets Really Work: A Quantitative Guide to Stock Market Behavior. I
received my copy just before hurricane Ivan arrived and was so fascinated by the subject
that I finished it that evening, storm and all. It presents 15 years of historical data (1/1/89
through 12/31/03) refuting much of what passes for "common market truisms." These
authors looked at several market criteria (new 5 and 10-day highs and lows, the impact of
being above or below the 200-day moving average, multiple day pullbacks, and others) to
evaluate how each impacted one day through one week returns for the S&P 500 and
Nasdaq 100 cash markets. Most of what they found went against our dearly held market
beliefs.
For example, during this period there were 947 10-day highs in the S&P. Buying the close of
a new 10-day high then selling one week later returned 0.0% on average with 53.43% of the
trades being profitable. Not too impressive, since the average 5-day return (irrespective of
whether a new 10-day high had been made or not) was +0.21%. Contrast this behavior with
buying a 10-day low then selling one week later. This strategy returned 0.56% on average
with 333 (of 557) profitable trades (almost three times the unrestricted average 5-day
return). The message: Buying strength hasn't worked as well as buying weakness! If one
buys the 10-day low but requires the S&P 500 cash index to be above its 200-day moving
average, the average return increases to +0.66% with a 66.43% win rate (190 winners of
286 occurrences). The authors put it this way: "...the greater opportunity and edge lies in
being a buyer as the market makes a new short-term low versus buying when it makes a
new high."
http://www.triplescreenmethod.com/MonthlyArticles/MonthlyArticle10...
1 of 4 16/08/2014 01:52
Following this theme, I tested three common patterns used for entering long positions in
individual stocks: three or more day pullbacks, new 21-day highs (breakouts), and new
21-day lows (bottom fishing). Chart 1 shows examples of each for ARO as they occurred
over a two-month period in 2003. To validate this study, I studied these three patterns for a
group of fundamentally sound stocks (9/24/04) with earnings and analysts rankings revision
fuel (Zacks rankings of 1 or 2) and value left in price (two year PEG ratios less than 1.25):
36 stocks shown in Table I were evaluated over the 294-day period between 7/30/03 and
9/28/04 (10,584 test days).
For the pullback, three or more lower highs were followed by a reversal candle. To limit
purchases to stocks in up trends, the 50-day moving average was required to be rising over
the last six days, and the 20-day moving average to be greater than its 50-day. When these
conditions were met, a long position was entered then exited at the close five days later.
Similarly, for the 21-day high, a position was entered when todays price exceeded the high
of the last 20 days, again, when the 50-day moving average was rising over the last six
days, and the 20-day moving average had to be greater than its 50. When these conditions
were met, a long position was entered then exited at the close five days later.
Finally, for the 21-day low, a new position was taken today when price exceeded the high of
yesterdays new 21-day low, this time with no additional conditions. And again, the position
was exited at the close five days later.
http://www.triplescreenmethod.com/MonthlyArticles/MonthlyArticle10...
2 of 4 16/08/2014 01:52
Tabl e 1
Table I provides results for each of the 36 stocks over the 294-day period. AMED, for
example, had 16 pullbacks meeting the required conditions and an average resultant
five-day gain of +3.0% (10 with positive gains and 6 with losses); AMED had 33 instances of
making new 21-day highs and an average five-day gain of +3.89%. AMED also had 6
instances of new 21-day lows and an average gain of +5.58%. Contrast these returns with
the average 5-day gain (+2.29%) earned from the control condition, i.e., from buying each
occurrence where todays price exceeded yesterdays high and holding for five days.
For these stocks, the average 5-day gain for the control condition was +1.27%, as these
were quality stocks performing in both bullish and bearish phases of the market. Limiting
buys to pullbacks increased returns to +1.84% (1.45x the control), to new 21-day highs
increased returns to +1.38% (1.09x the control), to new 21-day lows increased returns to
+2.59% (2.04x the control). Clearly, in this market, buying the new 21-day lows for a
week-long trade was a superior strategy to either buying pullbacks or buying breakouts.
These results are consistent with Connors findings for 15 years of S&P data. While
significantly longer holding periods lessens the importance of an entry strategy, the strategy
of buying 21-day lows reduces short-term risk and provides better risk/reward limits.
http://www.triplescreenmethod.com/MonthlyArticles/MonthlyArticle10...
3 of 4 16/08/2014 01:52

http://www.triplescreenmethod.com/MonthlyArticles/MonthlyArticle10...
4 of 4 16/08/2014 01:52