Unusual trading signals in individual stocks have historically been able to forecast a market about to fall. These warnings also give a heads-up for opportunistic entry points. At the end of the day, having a game plan to take advantage of volatility makes the ride much easier.
What we are seeing now is similar to other sell-offs led by unusual trading in stocks. In fact, I wrote about big selling last October. The set-up now is similar to then. Read that piece here.
Currently, we are expecting more near-term selling in stocks. Markets on average fall roughly 5% after a trigger occurs (more on that below). But remember, dips present opportunities for patient long-term investors. Because the signals are so rare, we pay close attention when they happen.
Mapsignals' goal is to identify tomorrow's top stocks today. We're basically looking for outlier companies with healthy fundamentals accompanied by outsized unusual institutional trading activity. By studying these data points, we can make an educated guess as to which equities institutions are trafficking in and marry this information with fundamentally sound companies. We want the odds on our side when looking for the highest-quality stocks.
Because we measure this activity on thousands of stocks every day, we have learned that stocks can move in unison to the downside. When this happens, like now, we can measure prior periods that were similar to today. Below is a quick summary followed by a few stats compared to our expectations:
SUMMARY: On May 30, 2019, our ratio of buying/selling in stocks is preparing us for an average market drop of 5.45% and an average of 13 trading days to get there.
A few observations on prior instances similar to now: 1) the market traded lower, which was expected; 2) the average trading days until reaching the local bottom historically is 13; and 3) the average return of the iShares Russell 2000 ETF (IWM) until the local bottom historically averages -5.45%.
Below you can see what this ratio looks like overlaid on IWM. I went ahead and circled prior periods when the ratio was declining in a straight line, like now. We tend to reach a capitulation point in the coming days or weeks.
Below you can see the prior times when our ratio fell below the key 45% level. You'll see that there is a lot of red until the local bottom (trough). However, this looks like an opportunity to me. Since almost all stocks fall in a correction, there are likely great stocks being dragged down that are diamonds in the rough. As a wise man once said, "Great stocks bounce like fresh tennis balls." This is what I've learned too, over my many years in the markets.
The Bottom Line
Unusual trading signals can provide opportunity. Long-term investors can unemotionally use history as a playbook for success. Pullbacks and oversold markets have been great chances to scoop up great stocks. Our long-term view is bullish on the market, and we feel that extreme pullbacks offer buying opportunities for the long run.
Disclosure: The author holds no position in IWM at the time of publication.