Tuesday, July 24, 2007

Festival of Falling Knives: NYSE 52-Week Lows

When a company's shares trade at their lowest price in the last 52 weeks, it is a sign of pervasive fear among many of the holders of that company's stock. Because most listed shares trade hands several times a year, it means that most current holders of that stock are sitting on an unrealized loss. Their fear often leads them to more selling as their shares hit new 52-week low prices, which is one of the reasons that buying companies hitting new 52-week lows is often referred to by traders as "Catching a Falling Knife": because you can be badly hurt if you buy such a company and it's shares continue to fall.

Today's trading on the NYSE exchange was, therefore, a sort of "festival of falling knives": 351 companies listed on the NYSE had their share prices hit new 52-week lows - more than at any time in the last 3 years. Unlike the previous "festivals" of 200 or more new 52-week lows, which occurred on October 12, 2005 and June 13, 2006, this festival did not occur after a broad decline had already occurred.

At the top of the chart shown above, I have added a barometer which shows the percent of shares listed on the NYSE that are trading above their average share prices for the last 50 days ($NYA50R). Such 50-day moving averages are widely used by traders and money managers, and are often used as shorthand for the trend of a stock: if a stock is above the 50-day moving average, it is trending up; if it is below the 50-day moving average, it is trending down.

When this barometer shows that only 20 percent of the shares listed on the NYSE are above their 50-day moving average, the market has usually already sold off pretty well (to what is called an oversold condition), and is generally due for a rebound. The previous festivals occurred when this barometer was showing just such an oversold condition, as shown by the green circles in the drawing above. These festivals punctuated long bouts of selling that left most of the companies on the NYSE trending down, and marked the end of the down trends for many of those companies.

Today's festival, in contrast, occurred when 37.27% of the companies listed on the NYSE are above their 50-day moving average - nearly twice the number seen in the previous events. So, if recent history is any guide, the market may have further to fall, and this festival may be just the warm-up for a bigger event in the near future.

To investors with a long time horizon and a hard nose for value, such events provide buying opportunities. But for most investors and traders, a new 52-week low in a stock that they own is a very unwelcome event. And a festival of falling knives, occurring out of the blue, when the NYSE is not oversold, is a very ominous event, indeed.

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