In this article, I will use the ratio between the two share classes of Berkshire Hathaway (BRK.A), along with the VIX, and other simple criteria to find days of extreme bearishness for identifying buy points for the Berkshire (BRK.B) and the S&P 500 (SPY). The goal of this article is to find days where there is an above average ratio between the share classes of Berkshire Hathaway, combined with strong bearishness in the Berkshire Hathaway stock along with overall market bearishness. I will show that days, which met the criteria below, have historically been strong buying points for an intermediate period. The list right below this paragraph shows the criteria I used to determine days that could be buy points for the S&P 500. In the paragraphs after the list, I will explain my reasons for using each of the criteria.
Buy Point Criteria
-Berkshire Class Ratio: >1510
-Volume: Double Average Volume
-Miscellaneous bearish Criteria: Close Down, Lower Low, Lower High
Criteria # 1: Berkshire Class Ratio
The first step I had to take was to calculate the ratio of Class A shares of Berkshire to Class B shares, so I used my thinkorswim charting platform and made a simple study that shows the ratio, and is in the chart below. The chart shows data for the last 4 years that the ratio [Blue Line] of the price of class A shares to class B shares rarely is above 1510. However, during extreme market stress as you can see from the left side of the chart, which is from 2009 that the ratio saw a significant increase. The reason the 1510 is significant is that since the start of the year 2000, there has 3570 trading days, and out of those trading days, on only 445 of those days or 12.46% was the ratio of A to B shares above 1510, so it is a rare event when it occurs. Therefore, as my first criteria for considering a buy point, I included that the ratio of A to B shares had to be above 1510.
Criteria # 2: Increasing VIX
I wanted to include an aspect that took into account the bearishness of the overall market, so I included the VIX. When the VIX increases that usually denotes more fear or bearishness in the market, therefore that I why I included it as part of my buy point criteria.
Criteria # 3: High Volume
I looked at the chart of Berkshire and noticed that many times when the stock fell while having at least double the 50 period average volume; it was a decent indicator of extreme bearishness in the stock.
Criteria # 4: Increasing Volume
This criteria is closely tied to the high volume criteria, because I noticed that when the stock was falling on increasing volume, and then had a big double volume day, that was a good sign of extreme bearish in the stock, and why I included it as a criteria.
Criteria # 5: Miscellaneous Bearish Criteria
To further hammer down the point that I was looking for days where there was extreme bearishness I included the criteria of the Berkshire stock closing lower than the open, with the stock failing to break above the previous days high, and at the same time making a lower low than the previous day.
I used the buy point criteria in my thinkorswim platform and found that since the start of the 2000, there have been 7 days, which met all the criteria, with the most recent being on February 3rd 2014. That is another reason of why I wrote this article because it is the first time a buy point has been signaled since September of 2011. The reason why the buy point occurrence is important is the strong returns that have occurred after previous buy point signals occurred. As I stated in the first paragraph the buy points provided strong returns in the intermediate period. In the table below are two columns the left column is the returns of the SPY from the buy point date, to the day where the price was the highest within the 6 months after the buy point occurred. The data shows that once a buy point occurred the average return to the highest point during the next 6 months for the SPY was 19.46%, and the average for Berkshire Class B shares was 27.15%.
In closing, I believe using the ratio of A to B shares of Berkshire is a strong base criterion, for determining when the market may have extreme bearishness and thus could potentially be due for a strong rebound higher. I have shown that when you combine the ratio with the VIX, volume, and other criteria, that there is potential for above average returns. However, as always past performance is no indication of future results, but past performance can give clues to market direction and increase the odds of a profitable investment. Going forward if history does repeat itself I would expect the SPY and BRK.B to have strong upward moves in the next 6 months. In addition, for those that have thinkorswim, I have provided the code for the study in my instablog here.
Disclaimer: See here.