Archive for November 19th, 2009

  • A Hint of a Correction

    Today we actually had a decent down day in the major stock indexes. However, the decline was still minor. If you take a look at the low of the day in the stock indexes and measure these lows from the highs which were made just a few days ago, this decline is between 1 and 2 ATR (average true range). A correction of this size from the highs is the size of a normal correction. In fact, many corrections are much deeper than what we have seen for the past few days. Most corrections are between 2 and 3 ATR.

    What is ATR and why use it to measure corrections? If I want to decide if an $8 move in Google is significant, I can’t use a fixed dollar value. Sometimes GOOG moves $5 on an average daily basis and sometimes GOOG may move $10 on an average daily basis. Plus if I am measuring price declines in a bull market, I want the ability to measure Google with the same measurement tool that I use to measure the stock of Apple or the crude oil futures contract. What tool can I use to measure these three very different markets?

    That tool can be ATR or average true range. If you want more information on ATR go to www.traderscountryclub.com and go to the Chart of the Day Tab. I placed a free lesson on ATR.

    Think of ATR kind of like the average daily range, but price gaps are taken into consideration with the use of ATR. A decline of 1 ATR from market highs is a decline of 1 average daily range. A decline of 2 ATR is a decline of 2 average daily ranges. In this way, when I say the average correction in a bull market is about 2-3 ATR from the highs, this means that in every traded instrument, it is not uncommon for markets to “correct” at least 2 of their average daily trading ranges.

    What does this mean for the average investor? The ATR for the SPY is about 1.65 on 11/19/2009. This means that it would not be uncommon for the SP 500 index to decline by almost $5 from the highs in the current bull market. A decline of this size would be normal. AAPL’s ATR is about 2.10. It would not be uncommon for Apple to decline by a litttle more than $6 from its highs and yet still retain the bull market bias. Google stock GOOG ATR is near $8. This means that Google can correct by more than $25 from its highs and yet still be a valid bull market.

    Now let’s use this knowledge as we analyze prices. What was the size of the correction in Google in early November? 2.9 ATR. AAPL correction for the same period was a little larger 4.0. Larger than normal, but still deserving of a bullish bias, in spite of the larger size of the correction. The size of the correction in the SPYDR SPY 3.6 ATR.

    Keep the ATR calculations in mind as you take a look at future corrections in the stock indexes, stocks and commodity trends. If the reversal from an old high is less than 4 ATR, you have to assume the decline is a correction and not a change in trend. If the correction is larger than 4 ATR, it is time to make a whole new analysis of the trend. There may a change taking place.

    We have not had deep corrections in the stock markets for some time, but now you know how to measure them. Not in percent; not in price, but in ATR.

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    2009.11.19 / no responses / Category: TCC