by Tom DeMark

Once a stock is listed on an exchange or added to an index, the potential for additional interest is enhanced considerably.  Index funds are required to include in their portfolios all components in various indexes, and margin requirements are often more attractive once an exchange listing is accomplished.  For these reasons, the potential audience is often increased significantly.  It is not uncommon to witness a price advance even prior to listing, in anticipation of this tendency.  Furthermore, many committees of large investment companies restrict investment to only listed stocks – and then only stocks priced in excess of $10.  Because of the criteria required for listing approval, these large investors use the listing process and the active requirements to remain listed as additional safeguards to ensure that they are investing prudently.  The reverse of the phenomenon occurs when a stock is de-listed.  Heavy liquidation of de-listed stocks, together with prospects of the company itself failing are legitimate concerns that are to be respected and expected.

I noticed the same tendency back in the early 1970s, when exchange-listed stock calls were first introduced.  It was almost a foregone conclusion that as soon as a call was listed, the underlying security would advance.  This pattern was dominant for an extended period of time until the exchange-listed puts were introduced and prices for the underlying stock declined for a short period of time.  Unfortunately, this tendency was short-lived.  In any case, I remain vigilant to observe the vagaries associated with the introduction of any new product in order to identify any inclination for the pattern to repeat itself.

New Highs – New Lows

Newcomers to a race track can always be expected to bet on the long shots.  Typically, those bets have odds over 50-to-1 and almost never win.  The smart money – the sophisticated gamblers – conduct their research and bet their money prudently and realistically; any expectations of a long-shot winner are left to inexperienced gamblers.  A long shot does occasionally win, amid as many bells and whistles as a big slot machine winner will hear in Las Vegas, but that outcome is the exception.  The same concept applies to the stock market.  Invariably, inexperienced traders like to focus on yesterday’s market winners.  History has proven that it is the exception indeed for a strong stock or industry performer in one bull market to repeat its preeminence in a succeeding bull move.  Generally, once it has become a fallen angel, it takes a number of market cycles to recover and lead once again.  Unsophisticated traders (and some experienced traders) ignore this fact and often become trapped in these losing propositions.

Common sense dictates that, as price declines more and more, owners of a stock incur losses.  For the stock to rally significantly to new highs, all the supply created by premature buyers on the way down must be overcome.  How many times have you entered a trade only to see price move immediately against you, and then said to yourself that once you break even you will liquidate?  Either these buyers must hold their stock positions and not liquidate, or their supply must be absorbed before price can advance.  If a stock is making a series of new highs in price, there are no unhappy buyers with losses.  Thus, the expectation of liquidation once the trader breaks even is gone.  Conceptually, the argument of overhead supply does not exist.  My experience of being a stock scavenger was short-lived, once I viewed the prospects in the context of overhead supply.  My research proved that stocks making new highs during an overall flat market were candidates for purchase because they were able to defy the laws of gravity displayed by the market indexes.  In fact, generally, they were leaders in the market during any period of strength.  Conversely, during a sideways market prior to decline, those stocks recording new lows were the leaders on the downside in any market sell-off.

Many years ago, I took my research regarding 52-week new highs–new lows and applied a technique that assigned a stock’s relative position versus its 52-week high or low.  For example, instead of just relying on the list of new highs–new lows as they appeared in the newspaper, I wanted to know precisely how close a given stock, presently at neither a new high nor a new low, was to recording one.  Often, the proximity of a stock to recording a new high or a new low is camouflaged.  An index I created, the TD New High/Low Index, provided me with a benchmark whereby I could confirm expectations of price breakouts either upside or downside.  The index is constructed by dividing the 52-week price movement of a stock by 10, and then ranking the stock on that particular day.  If, for example, price records a close today with 10 percent of its 52-week high, then a rating of 10 is assigned to the stock.  Conversely, if price records a close less than 90 percent of its 52-week high, then a rating of 1 is assigned to the stock.  If the price closes 50 percent less than its 52-week high, then a rating of 5 is assigned to the stock.  Next, I calculate a cumulative value and plot this index beneath the price action of a market index to validate price moves and trends to determine the durability and substance of a trend.  This method of evaluating the relative price close versus the price range of the previous year and then calculating a composite index (TD New High/Low Index) to validate overall market moves is a valuable contribution to the library of market indicators.  Once again, a basic, widely accepted indicator – new high–new low – is enhanced to create a more complete market indicator.  All it took was a little imagination and some creativity.

There are many other indicators designed to improve on those commonly used by most stock traders.  I believe the enhancements I have introduced here, as well as the integration of the various approaches into a composite, yield benefits that greatly improve the potential for trading success.