Review: Lowry’s 90% Downside Days

On January 28, 2014, Barry Ritholtz did a Bloomberg piece titled “Friday was a 90/90 Day and What It Means (found here)”.  In that article, Ritholtz explains the “90/90” as follows:

“When markets experience a bout of intense selling -- those trading sessions when 90 percent of the volume is down, and nine out of 10 stocks close lower -- it can mark a short-term reversal in a bull run. Typically, it signifies a shift in psychology among larger institutions.”

“Looking at the past examples of deep 90/90 sell offs, we have seen only modest rebounds followed by more selling after days such as Friday.”

In general, Ritholtz gives a vague idea on the concept however a detailed explanation is found in the 2002 article by Paul Desmond of Lowry’s Reports titled “Identifying Bear Market Bottoms and New Bull Markets (found here).”  In the Desmond article, there are some key concepts that are outlined.  Foremost is the idea that “…Important market bottoms are preceded by, and result from, important market declines…(page 3)” and “…if an investor had a method for identifying and measuring panic selling, at least half the job of spotting major market bottoms would be at hand...(page 3)”.

In the pursuit of identifying and measuring panic selling, Desmond’s research found that “…almost all periods of significant market decline in the past 69 years have contained at least one, and usually more than one, day of panic selling in which Downside Volume equaled 90.0% or more of the total of Upside Volume plus Downside Volume, and Points Lost equaled 90.0% or more of the total of Points Gained plus Points Lost…(page 4)”.  Desmond’s work on the topic covers the period from 1960 to 2002 with every date that the Dow Jones Industrial Average experiences 90% Upside or Downside days.

According to Desmond’s data set from 1960, there were 129 instances of 90% Downside Days and 67 instances of 90% Upside Days.  Desmond is clear to point out the importance of the Downside Days as a key for identifying market bottoms.  Additionally, Desmond makes a point of suggesting that single Downside Days carry less weight than multiple Downside Days over an extended period of time.

“A single, isolated 90% Downside Day does not, by itself, have any long term trend implications, since they often occur at the end of short term corrections. But, because they show that investors are in a mood to panic, even an isolated 90% Downside Day should be viewed as an important warning that more could follow (page 6).”

“The historical record shows that 90% Downside Days do not usually occur as a single incident on the bottom day of an important market decline, but typically occur on a number of occasions throughout a major decline, often spread apart by as much as thirty trading days (page 4).”

As our goal is to understand the downside risk of the stock market, we focused on the data related to the Downside Days. As all the data is based on back testing and hindsight, we thought the following review might prove substantive in future use of Lowry’s 90% Downside Days.  Our examination of the data found that only 27% of the listed Downside Days were of practical value to investors and traders.  That 27% was arrived at by looking only at the first instance of 90% Downside Day within an already declining market (measured from the prior market peak to the subsequent market trough).  It matters little to us to care about 90% Downside Days when the market is either trading in a narrow range or in an extended rising trend.  We assumed that if an investor were given only the first indication of a Downside Day within the parameters indicated, would they be able to make “rational” assumptions about the market going forward.

The result of our narrow interpretation of the data indicates that the average decline of the market, by the time of the first 90% Downside Day, was -48% of the total expected decline.  As an example, below is a chart of the Dow Jones Industrial Average from September 1976 to July 1978.  In the period of time from the prior peak on September 21, 1976 to the low on February 28, 1978 there were three instances of 90% Downside Days occurring on July 27, 1977, October 12, 1977 and December 6, 1977 (red dots).

Again, using hindsight as our guide, we can see that the first indication of a 90% Downside Day took place at -46.34% of the total decline from the peak at 1014.79 to the low of 742.12.  This was the “average” scenario that was played out when the first indication of a 90% Downside Day took place.

In the worst case scenarios, the market got the first 90% Downside Day signal after only declining less than 20% of the total decline that was to come.   Below is the table of those worst case scenarios:

On the whole, getting that first 90% Downside Day within a declining trend of a market that has already peaked usually serves as an indication that, on average, the decline is coming to an end.  This isn’t anything new except for the fact that 73% of the Downside Days may not be as material as the remaining 27% that we’ve identified.  What does this analysis suggest for the January 24, 2014 90% Downside Day?  On the conservative side the Dow Industrials could bottom at 15,144.16.  On the extreme the slide in the market could end at 14,076.66.  We’ll be watching to see if Lowry’s 90% Downside Day come through as it had in the past.

THE RESULTS as of August 28, 2019