Take a Lap: How Traders Get Fooled by Follow-Through

Two up sessions in a row. Time to buy, right?

Maybe so. But maybe not. Our research into what we call "lap up" markets might surprise you.

Looking back on millions of trades from 1995 through 2006, our research determined that, on average, traders would do better to fade, or sell, "lap up" markets rather than buy them.

Hard to believe? These findings are certainly counter-intuitive, but there's no denying the actual, quantified record. As Larry Connors and Ashton Dorkins wrote in a strategy article for our PowerRatings (for Traders)/Trading Markets Stock Indicators section almost a year ago, not only do stocks that "lap up" tend to have a negative bias, but also those stocks that "lap up" by more than 10% show a negative return on average of 1.12% after a week's time.

By contrast, those stocks that "lap down" by more than 10% have been shown to have a positive bias, tending to gain an average of 2.12% a week later. A "lap down" occurs when a stock opens below the previous day's close and finishes still lower.

So, what "lap up" / "lap down" opportunities are in the market today for traders to consider? Given the way the market has been moving (i.e., lower) over the past few days, I thought it made sense to look at "lap down" stocks. These are stocks whose holders are truly feeling The Fear, as the late Hunter S. Thompson used to call it.

There were no stocks that lapped down by 10% or more on the roster today. There were, however, more than a few stocks with "lap downs" of at least 5%--including three stocks that are "in the green" with PowerRatings (for Traders) of at least 8.

The highest rated stock in this list is Rick's Caberet International (NasdaqGM: - ), which earned a PowerRatings (for Traders) rating of 9. Rick's Caberet International owns and operates "gentlemen's clubs" which cater to an upscale clientele of businessmen and professionals. The clubs can be found in several states nationwide and feature bar and restaurant operations along with the live adult entertainment.

The two other top stocks in our "lap down by 5% or more" listing are Valhi, Inc. (NYSE: - ) and China Southern Airlines Company (NYSE: - ). Valhi, Inc., a chemical company involved in titanium dioxide pigments, component products and waste management, has a PowerRatings (for Traders) rating of 8. China Southern Airlines Company, on the other hand, is the ninth largest airline company in the world and the largest in the People's Republic of China. China Southern Airlines Company has a PowerRatings (for Traders) rating of 8.

David Penn is Senior Editor at TradingMarkets.com