Can Market-Makers Tell When A Stock Is Cheap? Are They Overpriced Now?

Includes: DIA, IWM, QQQ, SPY
by: Peter F. Way, CFA


Hedging by Market-Makers to protect firm capital (put at risk when facilitating block trades) tells how far – up and down – stocks’ coming prices may run.

Upside vs. downside price prospect balances allow direct value comparisons between stocks of all types at points in time – and aggregations of all stocks from time to time.

Here are their implied forecasts today.

The Market Profile for Equities on 6/15/2016

(used with permission)

The bottom scale units of this picture are in Range Index [RI] values. A security's Range Index value is the percentage of its whole price range forecast that lies beneath its market quote at the time of the forecast. A negative RI indicates a market price below the forecast range, and a RI above 100 marks a price above the range.

Over decades of experience the median/mode RI is ~43. Today it is ~27. Currently less than 6% of the 2461 equities plotted in Figure 1 have RIs above 50, the point where downside prospects are greater than upsides. Over 86% of the stocks and ETFs today have RIs lower than the historical average of 43.

What has happened to stock prices following forecasts?

Figure 2 looks at each day of the past 5 years, takes each stock being forecast, and measures its price change over the following 80 market days (16 weeks) and converts each interim week's cumulative change into CAGRs.

Those annualized changes are first aggregated into a blue row overall average. Then they are stratified by upside to downside proportions into rows and averaged. The rows have progressively more extreme up to down imbalances as they step away from the overall average, as indicated by the RWD:RSK row headers.

The #BUYS column indicates the count of forecasts in each row. The aggregate number of forecasts is over 2 ½ million. The magenta number indicates the current day's upside to downside forecast average.

Figure 2


It is rather apparent that these hedging-derived forecasts have some predictive capabilities.


While there are now a whole host of public worries with market price calamities attached, the view from market professionals, stock by stock, for the next several weeks is far from traumatic.

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information (earlier) helping professional and [now] individual investors discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations. We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for their guidance what the arguably best-informed professional investors, through their own self-protective hedging actions, believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, has further information.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.