Review of "How Markets Really Work"

In writing How Markets Really Work: A Quantitative Guide to Stock Market Behavior (buy from Amazon.com) Larry Connors and Conor Sen (son of fellow blogger Ron Sen, MD) set out to do for the stock market what Moneyball did for baseball -- debunk conventional wisdom trough the use of statistical analysis. This quote from the book sums up their goal for the How Markets Really Work:

If baseball has quantified mainstream parts of the game such as batting average, on base percentage, errors, steals, walks, etc., why hasn't Wall Street done the same with the indicators which it relies upon every day? Trading day after trading day, we are bombarded with information from the media. "The market rose for the third straight day as the bulls are taking charge." What does this mean? It sounds good, doesn't it? It sure feels like the market is going to continue to rise. A market rising three days in a row is usually rising because of good news. Isn't that a precursor of things to come? What about advancing issues and declining issues? On days the market drops sharply and declining stocks far outnumber advancing stocks, the press and the analysts tell us this is bad. Poor market breadth is supposedly a sign of future weakness. It seems to make sense. But is it true? (You'll soon see that it's not.)

The authors ran tests against historical data of the S&P 500 (SPX) and the Nasdaq 100 (NDX). Here are the concepts that were tested in the book:

• Short-Term Highs and Short-Term Lows - How does the market perform after making 5- and 10-day highs and lows?
• Higher Highs and Lower Lows - Examines if it's better to be a buyer after multiple days of higher highs and vice versa.
• Up Days in a Row vs. Down Days in a Row - How does the market perform after after it rises or falls consecutive days in a row.
• Market Breadth - How does the market perform after multiple days of advancing issues outnumbering declining issues? What happens after days with advancers outpacing decliners by 2-1 or 3-1 and vice versa?
• Volume - Another often reported statistic -- but how important is it?
• Large Moves - Is it better to buy or sell after the market moves up or down more than 1% or 2% in a day.
• New 52-Week Highs, New 52-Week Lows - Is the market necessarily healthier as more and more stocks make new 52-week highs?
• Put/Call Ratio - What exactly are high & low levels? Is conventional wisdom about how to act upon those levels correct?
  


• Volatility Index (VIX) - How best to use the VIX.

Each of those tests is presented in its own chapter. Each of those chapters presents the idea being tested and then explains the test results. There's not a whole lot of text in these chapters, just two or three pages per chapter. The authors do an excellent job of letting the data do the talking. The bulk of the chapters are graphs and tables. The final chapter gives the reader some ideas on how to use the findings presented in the book.

I think most people will be surprised by the findings in at least half of the chapters. The most surprising parts for me were the results with regard to market breadth, volume and new 52-week highs. I think that the information in this book is very important for anybody who's attempting to create or improve their own trading system. As I read the book I was reminded of a couple of articles that Connors wrote about buying breakouts. If you found those articles worthwhile then I'm sure you will find the book to be extremely valuable.

P.S. For other comments about the book see Bill Cara, Roger, Sharky and Michael Taylor's blogs.