Speed of Stock Index Decline as Future Return Indicator

Does the speed of a stock index decline from a recent high help decide whether to buy-the-dip or wait? In his April 2023 paper entitled “The 5% Canary”, Andrew Thrasher evaluates the whether the duration of initial 5% declines from 52-week highs for the S&P 500 Index and Dow Jones Industrial Average (DJIA) help quantify severity of subsequent drawdowns and attractiveness of buying the dip. Specifically, he defines:

1. A Canary signal as a 5% index decline within 15 trading days after a 52-week high, and two consecutive index closes under its 200-day simple moving average (SMA) within 42 trading days of a Canary signal as a Confirmed Canary signal.
2. The start of post-Confirmed Canary index uptrends (Buy-the-Dip signals) as the 50-day SMA crossing above the 200-day SMA.

Using daily closing levels of the S&P 500 Index during January 1950 through October 2022 and of DJIA during January 1900 through March 2022, and for some non-U.S. market indexes, he finds that: (more…)