Gavekal Capital: What Do Outside Reversal Days Portend for Stocks?

Friday, March 28, 2014

What Do Outside Reversal Days Portend for Stocks?

Over the past several weeks we've noticed a clustering of negative outside reversal days (defined as days when both the intraday high is greater than the previous day's intraday high and the close is lower than previous day's intraday low). The theory goes that these negative outside reversal days are symptomatic of stock distribution among institutional investors. If the theory holds then, we should experience clusters of negative outside reversal days around intermediate and major highs. To test the theory for the S&P500 we have created a chart that sums up all the negative outside reversal days over the last 65 days (roughly 1 quarter) and compares it to the price level of the index. What we find is that spikes in the 1 quarter sum of negative outside reversal days do in fact correspond to intermediate highs in the market, but by no means is this indicator perfect. It seems that readings of 4 or higher do often correspond with intermediate peaks in the price level, but the percentage decline is fairly ambiguous. It also does not follow that the higher the reading in negative reversal days, the bigger the forthcoming decline. In any event though, the consistency of the indicator to spike around the vicinity of intermediate highs is noteworthy so we will keep an eye on it.