Q&A: Paul Desmond of Lowry’s Reports

Part I of the Paul Desmond Q&A is posted at thestreet.com (free)

This is probably the coolest thing I’ve done at The Street.com:
Desmond is an extremely innovative and well regarded Technician, who
has made a number oif very important discoveries regarding how markets
operate.

If you read just one thing today, this is it. And Part II, coming tomorrow, is even better (no shit).

Here’s an excerpt: 

BR: Let’s talk about bottoms a little bit because I recall reading a paper
that you did that won the 2002 Charles Dow Market Technician
Association award. The study on 90% downside days.

PD: Yes. I had been reading a great deal of material about what market bottoms looked like. And one of the people that I happened to be reading was a fellow named of S. Gould, who talked about a classic market bottom in which he assumed it all occurred in a single day. That the volume was very heavy in the morning on the down side, that is stabilized in midday, and then by the afternoon, it was again rallying strongly again on substantially expanding volume. I simply went back through our history — which extends back to 1933 — and I was looking for those classic bottoms as Gould had defined them. I found very few — maybe one or two cases that fit his definition. But it became apparent to me that what he was talking about was an idealized situation and not actual experience.

So I went not only through his work, but through a number of other people’s work where they were talking about what a market bottom looks like. I could not find any of them that really worked or fit preconceived notions. So we started looking for some pattern that would help us to identify a market bottom. We knew that the most important consideration of a market bottom was panic; the final step in a downtrend is that investors panic and throw in the towel. They want to abandon the stock market without any consideration of the value of their portfolios.

BR: The classic expression is, just get me out, I don’t care about the price, I gotta make the pain stop.

PD: That’s exactly right.

BR: Looking at 1987, many people generally think that that was a one-day wonder to the downside — that it was a one-day debacle. But I’ve looked at the month before and saw a big build-up in volume and a pretty hefty decrease in price before that single-day crash. How did you find 1987 to be, compared to other bottoms?

PD: Well the panic stages of it occurred in three particularly important days. The first one was on the 13th of October, a Wednesday. And then the 14th was a Thursday, and that was a 100-point downside day. Now at that point, a 100-point downside day then was something very spectacular. The 14th was a 100-point downside day on the Dow and it showed intensity, and that is where we had our major sell signal on the 14th for October. Then Friday the 15th, the market also dropped 100 points. So to have two back-to-back 100-point downside days was pretty spectacular. Then on Monday morning, the 19th, the real crash, the 500-point drop, occurred. Now that was 90% downside day, which showed that there was real panic. (Editor’s note: Lowry’s defines a 90% downside day as those are characterized by a session with 90% downside volume in conjunction with 90% downside price action, meaning 90% (or more) of the price movement of all stocks on a given exchange is lower.)

BR: I’m looking at a chart of October ’87, and the Dow was about 2700 in the beginning of the month. Before we even got to that Wednesday (the 13th), the Dow was down to 2500. The volume really started ticking up on that 13th, 14th, 15th. The 19th and 20th were both the biggest-volume days of the selloff.

PD: That’s right. Actually, the interesting thing about 1987 is that most people incorrectly say ‘it just came out of nowhere.’ That the market was going up one day and suddenly crashed. And yet, we had a whole series of classic warning signs that the market was weakening. For example, the advance/decline line, which is a simple measurement of the number of stocks going up vs. the number of stocks going down, topped out in early April of 1987, showing that that was the point in which the largest bulk of stocks was starting to peak in price.

Our buying power index, which again, is the measurement of the amount of buying enthusiasm present in the market, topped out in late March of 1987. From that point on, the market was still going higher but was doing so with less gas in the tank, so to speak. And also we run an index called the selling pressure index that measures the amount of selling activity present in the market in any given time, and that was in a strong uptrend pattern, particularly starting in early August. And during that last rally attempt — the failed rally attempt in early September — the buying power index was dropping at a very rapid pace and the selling pressure index was rising at a very rapid pace, showing that buying enthusiasm had really been lost and that the sellers were trying to dump stocks as quickly as they could. That all occurred almost two months ahead of the actual break in prices.
 

Be sure and see part II before the weekend is over.

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Source:
Q&A: Paul Desmond of Lowry’s Reports
RealMoney.com, 2/18/2006 9:39 AM EST
http://www.thestreet.com/markets/marketfeatures/10269345.html