Buying Climaxes: Early Warning Signs?

Posted January 25, 2011

The S&P 500 stock index is up over 23% since last September 1st and there are increasing signs that the stock market rally is ready for a rest. In their Daily Market Report today Dorsey, Wright & Associates (DWA) pointed out one indicator that often signals a turning point in the market is an increase in “buying climaxes”.

What is a “buying climax”? A buying climax occurs when a stock (or index) makes a new yearly high, often early in a week but then declines and closes down for the week as a whole. A “buying climax” does not mean that a stock has finished its long-term move, or that a reversal in its long-term trend is imminent, it is simply a first indication that a near-term top has been reached.

Over the past few years we've seen some rather significant corrections begin with buying climaxes (last April for example), but many of them resulted in only modest setbacks afterward. It's important to recognize that it is an early warning event, and not a trend changing event. The Investor’s Intelligence research service shared the following in their most recent weekly update:


Excerpt: US Market Timing, by Investor's Intelligence for 1/24/11
"... Also noteworthy was the individual stock trading with a huge 569 buying climaxes. The markets show a five-month winning streak with spectacular gains and the large number of climaxes is certainly an indication that smart money is moving to the sidelines in a fairly big way ... Buying climaxes take place when a stock makes a 12-month high, but closes the week with a loss. They are a sign of distribution and indicate that stocks are moving from strong hands to weak ones. Selling climaxes occur when a stock makes a new 12-month low, but then closes the week with a gain. They are a sign of accumulation and indicate that stocks are passing from weak hands to strong ones. Our work shows that sellers into buying climaxes and buyers into selling climaxes are right about 80% of the time after 4-6 months time."

For the time being the short, medium and long-term price trends for the stock market are rising and stocks remain in a trend of outperformance relative to other asset classes. That being said we've seen something to warrant keeping our ear to the ground here and that is what we'll do. For the S&P 500, a move to new 52-week highs at 1,300 would show strength, while a decline below 1,270 from here would mark the start of a correction and would likely be joined by further weakness across the market. Some notable stocks that completed buying climaxes last week were Apple Computer AAPL, Amazon AMZN, Google GOOG, Qualcomm QCOM and Schlumberger SLB.