A brief commentary this week as we are traveling Friday afternoon to a wedding in Hana.

The mood is bullish after service industries started to grow, jobless claims fell, and Alcoa started the third-quarter earnings season with an unexpected profit. The DJI and S&P 500 both achieved their highest close for the year. The NASDAQ Composite was just short of its highest close which came on September 22. The predominant view is that earnings will be better than expected which will again drive the markets higher.

In the short term, this view is more likely to prevail than not, and in the long term, sayeth, Keynes, we'll all be dead. For some balance, in the medium term, our future may look more akin to that described in this piece from the Economist. The headline should be “You cannot print your way to prosperity.”

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As promised last week, we looked in more depth at the hypothesis that breakouts perform better if the volume on the day after breakout is at least as high as volume on breakout day.

We considered cup-with-handle breakouts back to January 1, 2004 and looked at three scenarios:

1. Performance of breakouts in the 12 months following breakout using the normal confirmed breakout rule.
2. Performance of breakouts in the 12 months following breakout when the following day's volume was greater than 150% of the average daily volume ( the volume requirement for a confirmed breakout)
3. Performance of breakouts in the 12 months following breakout when the following day's volume was greater than the breakout day volume.

In each case we calculated the average gain from the breakout price to the intraday high in the following 12 months. Stocks were considered to fail if they fell by 8% from their breakout price before making a gain of at least 5%. Failures were counted for each scenario.

Because it is unlikely that one can buy a stock at the breakout price after waiting for the second day's volume we looked at the premium that would be paid by buying at the close on the second day. The results are presented in the following table.

Conclusion

1. Breakouts with a second day volume greater than the breakout volume do perform better and have a lower failure rate.
2. The premium that is paid by waiting for the second day's volume to be confirmed negates the greater eventual gain.

If you have a comment or question, there is a thread running on the support forum under the topic "A Disciplined Approach to Opening a Trade".