A rare Buy Signal

http://www.marketwatch.com/story/a-rare-buy-signal-with-a-good-record-2010-04-21

By Mark Hulbert, MarketWatch
ANNANDALE, Va. (MarketWatch) -- If the trend is your friend, as the Wall Street cliché goes, then the stock market has been an incredibly friendly place of late.

I say this not just because the stock market, with seemingly little effort, was able to shrug off last Friday's news about Goldman Sachs' legal troubles, with the Dow Jones Industrial Average (INDU 11,204, +69.99, +0.63%) gaining 73 points on Monday and another 25 on Tuesday.

What I have in mind is a rare buy signal that was generated a couple of weeks ago by a trend-following indicator with a good long-term record. Prior to the recent buy signal, there had been only 12 of them since 1967.

And two of those 12 prior buy signals occurred in the last 12 months alone. In other words, between 1967 and March 2009, this indicator gave just 10 buy signals -- an average of just one every 4.3 years. Since March 2009, in contrast, they have averaged once every four months or so.

That's a very friendly trend indeed.

The indicator in question comes from Ned Davis Research, the quantitative research firm. It generates a buy signal whenever the percentage of common stocks trading above their 50-day moving averages rises above 90%. Davis refers to such events as a "breadth thrust."

The recent buy signal, according to this indicator, occurred on April 5. The other buy signals over the last year occurred on May 4 and Sep. 16 of last year.

How has the stock market performed following past buy signals? Quite well, according to Davis' calculations


Period after buy signal Average return of S&P 500 Worst experience Best experience
Next month 4.6% 1.1% 11.1%
Next quarter 8.2% 0.4% 13.7%
Next 6 months 13.1% 4.9% 24.3%
Next year 19.7% 11.6% 33.9%


It's worth noting, furthermore, that unlike many other trend-following indicators that have been biased upwards in recent years by the increasing number of interest-rate sensitive issues, Davis' calculations are based on a subset of stocks that eliminates closed-end funds, bond funds, exchange-traded funds, and the like.

Does this indicator mean you should throw caution to the winds? Of course not. As Davis points out to his clients, "one should never say 'never' regarding the stock market."

Nevertheless, as he went on to add upon reviewing the indicator's track record: "I still have to ask myself, 'When would it have paid to go against this indicator?'"