Editor's Note: This is a bonus story from Gary B. Smith, whose commentary usually appears only on
. We're offering it today to
readers. To read Smith's commentary regularly, please click here for information about a free trial to
, my friend Doug Kass likes to say that stocks have no memory from day to day. That is, Monday's price action has no direct bearing on Tuesday's price action. This is gospel, of course, to fundamentalists, but is it true?
It's fairly easy to test, and so I did, using my typical sample set of the
. My parameters were straightforward, and I tested four different conditions:
Today's close is higher than yesterday's close;
Today's close is higher than today's open;
Today's close is lower than yesterday's close; and
Today's close is lower than today's open.
As you can see, Nos. 2 and 4 above really test if the intraday price action has an effect, while Nos. 1 and 3 test end-of-day action.
And what exactly did I measure? As I have with many tests in the past, I looked at "expectancy," which, as you'll recall, is calculated as follows:
win percentage) - (loss rate
My time frame was from mid-1985 through the present, assuming a buy at the close and a sell at the next close. In reality, that would be hard to replicate: With many stocks, you wouldn't know if the stock closed up or down until the final seconds.
Still, we're not trying to develop a trading methodology, but rather trying to test Doug's hypothesis.
Here were the results:
- Condition 1 (today's close higher than yesterday's close): 0.09% expectancy
- Condition 2 (today's close higher than today's open): 0.15% expectancy
- Condition 3 (today's close lower than yesterday's close): 0.76% expectancy
- Condition 4 (today's close lower than today's open): 0.75% expectancy
Conclusions? It appears that Doug is correct if he's referring to stocks that are up, either from the open or from the previous close. As you can see, the expectancy there is negligible, indicating that those stocks, indeed, have no memory.
But if stocks are down, again based on the previous close or that open, expectancy skyrockets, making it appear that stocks do have a memory -- one that's only likely to recall the good, not the bad times!
It's interesting, and it brings up an important point. Regardless of how you trade or invest, you have a slight edge from the start if you buy stocks that are down the previous day, rather than up. Go figure.
Today, charts for the
Dow Jones Industrial Average
Charts produced by TC2000, which is a registered trademark of
Worden Brothers Inc.
And that is the final word from the Anacostia River, where despite the never-ending winter, high school rowers are back on the water. They're a hardy bunch. I'm telling you, when that wind blows, it's bitter out on the water!
Please note that due to factors including low market capitalization and/or insufficient public float, we consider American Superconductor and BlueLinx to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
Smith writes a daily technical analysis column for RealMoney.com and also produces a daily premium product for TheStreet.com called The Chartman's Top Stocks --
click here for a free two-week trial. While Gary cannot provide investment advice or recommendations, he invites you to send your feedback to