Recently, an odd email made its way into my inbox, which came from a competing financial publication platform showcasing compelling stocks to buy based on quantitative research. As someone who has been heavily diving into the topic, I was eager to read about the underlying algorithms and probabilistic insights.
To say I was disappointed would be a massive understatement.
Essentially, the article was nothing more than quantitative sorting, which is a completely different concept. Rather than a mathematical foundation, the write-up presented a litany of presuppositional fallacies — that a “low” valuation ratio equated to a market mispricing — arranged in a quantitative manner. It was the financial equivalent of an Italian restaurant advertising its tacos or a Chinese restaurant hawking its sushi.
To be clear, quantitative analysis is the application of mathematical, statistical or computational techniques to measure, model and forecast outcomes based on structured, empirical data. A true quantitative system places a strong emphasis on objectivity, testability and probabilistic interpretation.
This is the main reason why I focus on market breadth or the sequences of accumulative and distributive sessions. Not only is market breadth a representation of demand and thus effectively binary in nature, the metric is also a first-order principle. This is a fancy term that the concept is mathematically irreducible.
Compare the above framework to technical analysis. Practitioners of technical analysis will base their projections on pattern interpretations, such as cup and handle or head and shoulders. The problem with this approach — aside from the glaring falsifiability dilemma — is that such interpretations can be reduced.
Think of a giant hamburger. Most people don’t have giant mouths so they deconstruct the burger with a steak knife and eat half of it (or a quarter of it). Similarly, a technical pattern can be deconstructed into simpler, constituent behaviors, such as just a cup without the handle or a head without the shoulders. However, this reducibility opens the door for subjective reinterpretation, among other manipulations.
Market breadth? It can’t be reduced and thus my theory is that it can serve as a legitimate basis for understanding the market’s behavioral profiles — and more importantly, the likelihood of transition from one profile to another.
On Friday, off-price discount retailer TJX Companies (NYSE:TJX) was one of the highlights in Barchart’s screener for unusual stock options volume. Specifically, total options volume reached 15,880 contracts, representing a 78.43% lift over the trailing one-month average. Call volume clocked in at 11,383 contracts versus put volume of 4,497 contracts. Options flow — which focuses exclusively on big block transactions — was $13,200 above parity, slightly favoring the bulls.
On a quantitative basis, the past two months of price action for TJX stock can be converted as a 4-6-D sequence: four up weeks, six down weeks, with a negative trajectory across the 10-week period. Admittedly, this conversion process compresses TJXs magnitude dynamism into a simple binary code. However, the benefit is that this code can be categorized into different behavioral profiles, which can then serve as the basis for empirical probabilistic analysis.
Since January 2019, whenever the 4-6-D sequence flashed, the following week (which corresponds with the business week beginning June 30) has a 61.29% chance of seeing upside, with a median return of 2.37%. As a baseline, the chance that a long position in TJX stock will be profitable over any given week is 55.46%. Therefore, an incentive exists — if you believe in this quantitative model — to take a long shot on TJX.
Assuming that the bulls maintain control of the market, TJX stock could reach around $128 over the next three to four weeks.
While gold has been a hot commodity, South African miner AngloGold Ashanti (NYSE:AU) suffered a noticeable decline last week. In the past five sessions, AU stock fell 8%. On Friday, AU slipped more than 5%, leading to a spot on Barchart’s unusual options activity screener. Total derivatives market volume reached 3,698 contracts, representing a nearly 22% lift over the trailing one-month average. Call volume outpaced puts, 2772 contracts to 926.
Although the above picture may look bullish, options flow data showed that net trade sentiment was $500 below parity. That’s not particularly pessimistic but it’s hardly an endorsement. Still, with the market being hesitant on AU stock, the red ink could potentially be a discounted opportunity for speculators.
Here’s the thought process behind this assertion. In the past two months, AU stock printed an unusual 7-3-D sequence: seven up weeks, three down weeks, with a negative trajectory across the period. Even though the balance of accumulative sessions outweigh distributive, the overall trajectory during the 10-week interval was negative.
However, the above pattern has tended to be a reversal signal. In 60% of cases, the following week’s price action results in upside, with a median return of 7.72%. As a baseline, the usual long-side success ratio is 53.1%.
On Friday, AU stock closed at $43.88. Over the next week or two, look for AU to reach above the $47 level.
Generally, I don’t like dealing with small- to mid-capitalization enterprises in the pharmaceutical and biotech space due to their penchant for wild volatility. In that regard, Apellis Pharmaceuticals (NASDAQ:APLS) is a typical sector player. Since the start of the year, APLS stock dropped more than 45% of equity value.
Still, if unusual options activity is an indication, Apellis may warrant another look. On Friday, total options volume hit 4,650 contracts, representing a leap of almost 540% over the trailing one-month average. Call volume was 4,628 contracts versus put volume of 22 contracts. Options flow also showed net trade sentiment at $23,200 above parity, modestly favoring the bulls.
Notably, in the past two months, APLS stock printed a 3-7-D sequence: three up weeks, seven down weeks, with a negative trajectory across the period. At first glance, the balance of distributive sessions far outweighing accumulative sessions may worry investors — and it should.
However, the 3-7-D historically acts as a reversal signal, with the likelihood that the next week’s price action being positive standing at 58.33%. As a baseline, the long-side success ratio of APLS stock over any given week is only 48.08%.
On Friday, APLS closed at $17.43. If the implications of the aforementioned sequence pan out, look for the security to reach $18.80 to $19 over the next two weeks.
