Wednesday

False High Break Out Analysis

Post a Comment July 15, 2009 – 4:26 pm |   | Permalink |  Print This Post |

The Dow is powering ahead with the ASX Futures now up almost 2.2% at 3992. If the physical market hold on to the gains tonight, that would be 3.4% Tuesday, 1.48% Wednesday, and 2.2% Thursday consecutive gains. At this level, it is a worthy short - for even if one were wrong and markets are meant to head higher, we would expect a pull back to recharge before going up. The Dow is now trading at 8544, 30 points shy of a high break out. The conventional teaching is to close your shorts and go long if the high break out is breached (conversely if a low break out is breached, then cut your losses and turn short).

We looked back to 1960 and identified all the days where the high of the day exceeded the high break out (HB). There were 157 events where the intraday High > HB. Of these, only 50 closed above the HB. So 1/3 are true break outs, whilst the remaining 2/3 are False break outs.

www.theinflationist.com

www.theinflationist.com

Y Axis: High of Day minus HB

X Axis: Close of the Day minus HB

Summary of High Break Out Facts:

• 2/3 of High Break Outs are false breakouts (only 1/3 close above the HB)
• The higher the percentage above HB, the more likely it will close above HB - ie if markets break above HB significantly, chances of a true break out is higher. The cut off appears to be around 1% (ie plots are skewed > 0 on X axis above the 1% mark).
• Below 1% (ie High minus HB <1%); the probability of a false break out (ie reversal to close below HB) is higher.
• Of the 157 days where the high broke above HB, only 7 reversed to close down (ie below previous day). So once HB is hit, the chance of a 180 degree reversal is VERY low.

Applying this to today’s move

• Note: The Dow needs to break above 8570 before the above applies. If it does, then 2/3 will still close below 8570, whilst 1/3 will remain above 8570.
• 4.4% chance (7/157) for an intraday reversal to shed all 186 points to close below 8359
• For what happens the day after HB is broken, please refer to our previous analysis (note: the Day After A High Break Out Analysis was based on ASX - we will do one for the Dow in future) - the chance of the low of the day being below todays close will be 83%.