The 200ma Cross

The Nasdaq 100 led the way today as it rose over 3% and closed decisively above its 200-day moving average. It is the 1st major index to retake the 200-day (the S&P mid-cap 400 also did it today if you consider that one major). Some people believe the 200-day moving average is an important technical measure. Some suggest it’s a somewhat meaningful psychological level. Others see little value in looking at it. Rather than discuss and postulate on the merits of an indicator, I prefer to test it. Let’s see what a cross of the 200-day moving average in the NDX has led to in the past. (Test period is mid 1986 – present.)

Over the period tested the average gain per day in the Nasdaq 100 was just under 0.09% ($90). As you can see, the market seemed to gain steam after crossing the 200-day moving average and strongly outperformed the typical period.

What if we add a filter to eliminate those times where it barely peeked across? I filtered to only look at crosses that finished at least 0.5% above the 200ma. Results below:

These results are even stronger.

How about if we also require that the NDX makes a good-sized move on the day of the cross? I used a 2% gain to test this. More results:

Whatever the reason, a move through the 200-day moving average has provided the NDX some extra fuel in the past. When the move was strong and decisive like Thursday, that made for even better results. A cross above the 200-day moving average isn’t a magic buy signal – but there are worse ones.

Image courtesy of DialBforBlog.

Fed Reaction Not As Ugly As It May Seem

Last night I showed that when the Fed disappoints and the market drops by 1% or more in reaction to it, then the market has generally recovered and worked its way higher over the next couple of weeks.

The Fed disappointed today, although not to the degree we looked at last night. The S&P finished down a relatively mild 0.4%. While the end result wasn’t that poor, the fact that it was up 1% shortly after the announcement and then faded late left many traders with a bad taste. Measuring where in its range the market closed the day is one way to measure the mood near the end of the day. Today the market closed very close to its lows. I ran a test to see how the market performed after closing near its lows on a Fed day. Results below:


Looks fairly positive. Since I’d already established moves of 1% down or more could be a positive, I decided to exclude those instances from the results and re-run it:


Not quite as strong, but still a slight upside edge seems apparent.

Also notable about today was the fact that the market made a recent high. I ran a test to see the following 1) Fed day 2) Made 20-day high. 2) Closed in bottom 10% of range. I was only able to find 3 instances. Therefore I removed the Fed day requirement. Below are those results:


The first few days were choppy, but certainly not bearish. After that the market generally rose.

Some technicians may suggest today was an ugly late-day reversal. I’m having trouble finding much ugly about it.

What A Strong Reaction To The Fed Could Lead To

Last month I presented historical returns following days when there was a strong reaction (+1%) to a Fed (pictured at right) announcement. The results showed that the positive reaction was typically short-lived. Another highly anticipated Fed announcement is due tomorrow. Tonight I thought I’d present historical returns following a disappointment (just in case).

As you can see, a strongly negative reaction to a Fed announcement has typically been followed by a very positive next two weeks. So…if the Fed does something the market “likes” it will go up tomorrow, but over the next two weeks returns will likely be disappointing. If the Fed disappoints the market tomorrow we’ll see afternoon weakness. This disappointment could lead to a nice rise over the next two weeks. So the bulls should want the Fed to upset them tomorrow, and the bears should hope for a short-covering rally.

I find these tendencies to be quite interesting. My untested (as of yet) theory on why this occurs is that “good” news normally will come in the form of a rate cut or other stimulus. This kind of good news happens during times of economic and market weakness and the improvement for both can take time. “Bad” or “disappointing” news many times will come in the form of tightening. The Fed tightens normally when the economy and markets are strong. Just as they can’t fix it in a day, they can’t break it in a day either. Their “bad” decision won’t derail a rally right away and the market will typically continue to trudge higher for a while.

Whatever the reason, the point to remember is this: Don’t get too caught up in the reaction to the Fed tomorrow. The move likely won’t last longer than a day or two before reversing itself.

Edit note: Test was run back to 1982.

Bearish Bar But Fed Looming

Last week I showed how very low volume in a short-term uptrend is a negative. It happened again today along with some other action that hasn’t been constructive historically. Here’s a quick look at what happens when several negative all come together:


For those who would like to review the previous instances they were 6/2/94, 11/6/00, 11/13/01, 10/28/02, 11/29/02.
You don’t want to read too much into just 5 instances, but the formation has been quite bearish in the past. Of course as I mentioned last night, the Fed announcement Wednesday will likely have a larger influence on short-term direction than historical precedents.

Ten High Straight Up

I’ve previously discussed some of the findings in Larry Connors’ book “How Markets Really Work”. In the book Larry looks at certain market situations and determines whether the market has historically outperformed or underperformed when those situations arose. One I previously discussed was a 3-day rise in the market when it is trading under its 200-day moving average. Historically, the market has struggled to add further gains after this has occurred.

Another edge Larry discusses in his book is performance following a 10-day high. In the book he shows there has been a negative expectancy over the next 1-5 days following a 10-day high. I have personally examined 10-day closing highs and found a negative expectancy 3-5 days out when the market is under its 200-day moving average. When it is over the 200-day the expectancy is no longer negative.

On Friday the S&P 500 closed higher for the third day in a row. It also made a 10-day high and closed at a 10-day closing high. I ran some tests to see what happened when you combined some of these 10-high criteria with 3-straight up days. Results of the different combinations I looked at were similar. Below is one example:

A negative expectancy persisted up through 12-days out. The greatest part of it appeared in the 1st three days. Of course during the next three days there is going to be a Fed announcement. The reaction to that may have a larger affect on market movement than my little test. Still, it’s worthwhile noting the negative expectancy in these situations. Below is a chart showing all the recent instances with a 3-day exit strategy.

Are The Leaders Suggesting A Market Meltdown Or A Sector Rotation?

While the major indices faired well on Thursday, the IBD 100 got whacked. Only 28 stocks rose and the Index declined over 2%. (Hat tip to IBDIndex.) I noticed this has been an especially bad week for the IBD 100. While the S&P 500 is only down 2 points the IBD 100 is lower by almost 3.5%.

The IBD 100 is a group of 100 stocks compiled by Investors Business Daily that represent market leadership. Unlike more traditional indexes, it is updated weekly and turnover on the list is quite high. Since it is supposed to represent current market leadership, I was curious to see if the strong underperformance so far this week would be significant if the major indices actually managed to close positive. In other words, in a generally rising market, does a breakdown in leadership signify sector rotation, or is it a sign that the indices will soon follow the leaders south?


I looked back at weekly data to 3/12/2004, which is all I had available for the IBD 100. There have only been 3 times when the IBD has lost as much as 3% while the S&P has managed to finish the week positive. They were 3/10/06, 7/21/06, and 3/21/08. Below is a chart of all the instances where the S&P has had a positive week and the IBD 100 has dropped at least 1%.

I’ll let you draw your own conclusions, but I’m having trouble finding anything that would suggest a meltdown is imminent. It appears the next 3-4 weeks have often been positive following these instances.

Note: If anyone has or knows where I could find the daily IBD 100 Index values going back to its inception in 2003, please let me know. Thanks.

Intraday Extremes

The price action on Wednesday was quite interesting from an intraday perspective. I’ve posted a chart of SPY below. What sticks out to me it the fact that there were two extreme price moves in close proximity of one another. The chart is a five minute chart, which is the intraday chart I look at most often. Notice the two arrows with notes attached.


When you get a strong and steady move like was seen from 10:10 to 10:55 or in the opposite direction from 11:55 to 12:25, one indication that it may be nearing its end is if a large range bar is posted.

To help illustrate this concept I ran some historical studies. The first one looks to sell short any time there have been at least 6 up closes and the most recent bar makes the largest rise of any bar in the move. It then sells “X” bars later or at 4:00 – whichever comes sooner. No trades are taken before 9:50.

As you can see, selling into this extreme move has a positive expectancy from 5-50 minutes out.

The second study looks at exactly the opposite formation. It buys the SPY any time there have been at least 6 down closes and the most recent bar makes the largest decline of any bar in the move. It then covers “X” bars later or at 4:00 – whichever comes sooner. No trades are taken before 9:50.

Again you can see that the edge is for a counter-move rather than a continuation for at least the next 5-50 minutes.

The large bar after the steady trend many times signals a blowoff. It can be a good place to take profits if you are in a trade, or perhaps begin to look for a reversal. This is not a daytrading system by any stretch, but it does illustrate a concept that daytraders may want to keep in mind.

Mid-Sized Gaps Down

With little notable action today I thought I’d write up the next part of my study on gaps during uptrends vs. downtrends. Last week I looked at mid-sized gaps up. Tonight I will look at mid-sized gaps down. As a refresher, a mid-sized gap is defined as a an opening between o.25% and 0.75% away from yesterdays close. A long-term uptrned is defined as a close above the 200-day moving average and a long-term downtrend is defined as a close below the 200-day moving average.

I looked at 3631 trading days going back to 11/17/93. Of those there were 368 mid-sized gaps down in uptrends and 222 mid-sized gaps down in downtrends.

Buying at the open and selling at the close when the market was in an uptrend would have resulted in 177(48%) winners and in total gained 8.5% over the 368 trades. On a per-trade basis that’s 0.02% – basically break even. Of those gaps down 213 (57%) filled at some point during the day. (A fill in this case is defined as a move back up to the previous day’s close.)

Buying at the open and selling at the close when the market was in a downtrend would have been profitable 98 (44%) times and LOST you almost 32% over 222 trades. Per trade that’s about a 0.14% loss on average from open to close. Of those mid-sized gaps down, 152 (68.5%) filled at some point during the day.

I previously showed that large gaps down in downtrends typically represented an intraday buying opportunity as they had a large positive expectancy. Mid-sized gaps do not act the same at all. They contain a negative expectancy. Interestingly, although a good percentage of them fill, they also generally fail. Fading the open could be one play. Another could be looking for a short entry after the gap fills.

As I said last week, make sure you take the following two things into account when deciding how to approach a gap opening: 1) Long-term trend of the market. 2) The size of the gap. They both matter.

Edit note: SPY was used for the above test.

Is Buying Drying Up?

When looking at the market statistics today, the one thing that really stood out was the complete lack of volume. The exchange market volume was nearly the lowest of the year. The SPY and QQQQ volume WAS the lowest of the year.

Back in March I busted the old “light volume pullback after a short-term runup signals a healthy consolidation” myth. Today I’ll look at it a little bit differently.

Only 2 conditions – 1) Today’s volume is the lightest in at least 20 days, and 2) the market is trading above its 10-day moving average. I don’t care whether the market is pulling back or not for this test. I only care if we see exceptionally light volume during a short-term uptrend.

Using these conditions I ran tests on both SPY (back to 1994) and QQQQ (back to 1999). Results below:

It appears buying interest is drying up. In the past the market has not fared well under these conditions.

Some may point out that these results differ greatly from the breadth study I showed yesterday. It appears breadth and volume are currently giving opposite indications. Studies that conflict make analysis more difficult. In the Subscriber Letter each night I discuss my take on all the recent studies. In the blog in the near future I will write some detailed thoughts on how I go about doing this.

Strong Breadth To Finish The Week

A quick breadth study to share with you this morning. Wednesday and Friday’s rallies were both accompanied by strong breadth figures as advancers outnumbered decliners by more than 3 to 1. I looked back to 1969 to see how the market performed in the past when breadth readings were at least 3 to 1 positive in two of three days. Results below:


These results appear strongly favorable. The average week over the sample period returned 0.175%. The results above beat the average by more than 3 to 1 from 1 to 4 weeks out. Last week’s action appears quite bullish.

Morning Breadth

Tonight…some indicator analysis. I think many times traders focus too much on pattern recognition and therefore only look at price. This is especially true of intraday traders. Looking at price and price-based indicators is like looking at the Grand Canyon on a black and white TV. You can see it, but throw in volume and maybe you’ll get some color. Breadth could get you HD. Sentiment gives you surround sound. Add some intermarket analysis like Dr. Steenbarger employs and some historical studies like I prefer and you might actually get to view it for real. Tonight I’m going to look at breadth.

Many traders look at breadth measures like the Advance/Decline line or the McClellan Oscillator on an end-of-day basis. But let’s examine whether intraday breadth analysis can lend some value.

I ran a test back to April of 2001 looking at 15 minute bars in the SPY, the NYSE Advancing Issues and the NYSE Declining Issues. I wanted to see if strong or weak breadth in the morning led to price strength or weakness throughout the rest of the day. The rules for this test were fairly simple.

If advancers led decliners by 4-1 at 9:45, then I would buy the SPY and sell it at 4pm.

If decliners led advancers by 4-1 at 9:45 then I would short the SPY and cover it at 4pm.

Results:

4-1 Advancers:
Trades: 33
Winners: 17
Losers: 16
Avg Win: 0.8%
Avg Loss: 0.5%
Avg Trade: 0.2%
Profit Factor: 1.72

4-1 Decliners:
Trades: 36
Winners: 23
Losers: 13
Avg Win: 1.0%
Avg Loss: 1.3%
Avg Trade: 0.2%
Profit Factor: 1.36

In general, strong advance/decline numbers in the early morning show a mildly positive expectancy in the SPY for the rest of the day while weak a/d numbers show a mildly negative expectancy for the rest of the day.

Traders may benefit from tracking early morning breadth statistics. While this is certainly not something you would want to trade on its own, it may help to confirm or filter trades you are considering. Using breadth in conjunction with price and other kinds of analysis can make for a potent combination.
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For those who would like to explore this concept more it is available for purchase and download in Tradestation format here. The study comes with flexible inputs to adjust times and breadth requirements. A pre-set workspace is also included.

Performance After A Gap And Go Day

One test I ran tonight looked at performance following a day when the market gapped up at least 1% and then tacked on another 1% from open to close. The first table below shows the results for the QQQQ:

Results here are quite negative.

Next I looked at the SPY:

Here results were more mixed with the max loss accounting for all of the losses in most time periods.

I also looked to see how often the gap up got filled when the market was trading below its 200 day moving average. For the Nasdaq 55% of the time the gap was filled within 5 days and 74% of the time within 10 days. For the S&P the results again were not nearly as negative. Only 41% were filled within 5 days and 55% within 10 days.

A partial retracement of today’s move at some point seems likely. It may or may not be a few days before that begins, though.

Mid-Sized Gaps Up

After the close today, Intel had a good report. Everyone seems happy (unless you’re short Intel.) The Nasdaq futures are juiced and the S&P’s are even up quite a bit as I write this. We stand a good chance of seeing a gap up tomorrow morning. There are some economic reports to deal with before the opening bell so things can clearly change, but it seems like a good idea to expect we may gap in the morning and to plan for it.

Previously I’ve looked at large gaps up as well as large gaps down, and how the market reacted to them in both uptrends and downtrends. Today I will look at mid-sized gaps up.

As a reminder I previously defined a large gap as one over 0.75% for the SPY. The mid-sized gaps I’m looking at tonight are gaps between 0.25% and 0.75%. Once again I will break the results out between mid-sized gaps up in uptrends and mid-sized gaps up in downtrends. You’ll find the results to be quite different from both each other and the large gap studies.

For uptrend vs. downtrend I kept it simple and used the same definition as last time. If the market closes above its 200-day simple moving average, it’s in an uptrend. If the market closes below it, then it’s in a downtrend.

I looked at 3626 trading days going back to 11/17/93. Of those there were 613 mid-sized gaps up in uptrends and 223 mid-sized gaps up in downtrends.

Buying at the open and selling at the close when the market was in an uptrend would have been profitable about 50% of the time. In total the market would have gained 3% over the 613 trades. On a per-trade basis that’s basically break even. Of those gaps up 356 (58%) filled at some point during the day. (A fill in this case is defined as a move back down to the previous day’s close.)

Buying at the open and selling at the close when the market was in a downtrend would have been profitable 54% of the time. In total, though this strategy would have LOST you almost 66% over 223 trades. Per trade that’s close to a 0.3% loss on average from open to close. Of those mid-sized gaps up, 165 (73%) filled at some point during the day. Even with a slightly higher winning percentage these stats are significantly worse than those above dealing with uptrends.

We previously found that large gaps up typically lead to more upside during a downtrend. Most likely this is because shorts get trapped and the market runs as they scramble to cover. Mid-sized gaps are a different animal. They are not as scary for the shorts. Shorts may even see it as an opportunity to add more exposure, while longs look to take gift profits. Whatever the reason, the long-tem downtrend is generally able to re-assert itself during the day and those that bought into the early morning excitement get punished.

When deciding how to approach a gap up in the morning, make sure you consider at least two things: 1) Long-term trend of the market. 2) The size of the gap. They both matter.

What Happens When Range Rapidly Contracts

In the 1980’s Tony Crabel published research on Wide Range Bars and Narrow Range Bars. He introduced the concept of WR7’s and NR7’s. A WR7 is a bar whose range is wider then the previous 6 bars. An NR7 is a bar whose daily range is narrower than the previous 6 days. Others have done work with WR and NR bars since then including Linda Bradford Raschke and Larry Connors – both separately and together. Their book Street Smarts contains a pattern which uses historical volatility and NR4 bars to look for explosive moves.

The market’s steep selloff on Friday created a WR7 bar. On Monday the selling quieted and the market actually put in an NR7 day. While volatility tends to be mean reverting, it’s unusual to see it contract that fast. I look at the action in the NDX back to 1986 when a WR7 with a lower close was followed by an NR7 the next day. Buying on the close of the NR7 day and holding for “X” days achieved the following results:

It appears the inability of the sellers to follow-through after the wide range day down invites buying over the next several days. In the very-short term (1-3 days) the bias is strongly bullish. Consider the fact that the average day over the period tested was a 0.06% gain. The one day performance following this setup was over 10-times a normal day and over three days it outperformed and average three days by over 5-times. The high win rate and average win size consistently higher than the average loss make this setup intriguing.

A few other notes: 1) Whether the NR7 day was positive or negative had little impact on performance and was not differentiated in the results above. 2) A WR7 up bar is a less bullish setup – but I’ll look at that in more detail when the time is appropriate.

Sharp Drops In Consolidations – Bad News

Friday the market got ugly. The S&P sold of more than 2% and the NDX dropped almost 3%. My take is that we have a strong selloff within a consolidation period. The market is trading right where it has been many, many times since the 3rd week in January. The sideways action of the last 2-3 weeks is basically a continuation of the sideways action over the last 2-3 months. As most traders are aware, markets act differently depending on their overall direction. Uptrends have different characteristics than downtrends which have different characteristics than sideways markets. So I decided to take a look at market performance following a strong selloff in a sideways market. First I tested the S&P 500 under the following conditions:

1) Dropped at least 2% today.
2) Did not make a 10-day closing low. (Suggesting no breakdown.)
3) 14-period ADX is less than 20. (Suggesting congestion.)

Buying when these conditions occurred and selling “X” days later produced the following results looking back to 1960:

Negative expectations and very low % profitable. Quite negative on a small sample size even as far out as 4 weeks. For those that would like to take a closer look, here are the dates: 6/23/70,12/02/74, 1/7/81, 4/14/88, 5/14/99, 2/9/00, 1/5/01, 10/29/01, 9/12/02, 11/1/07, 12/11/07, 4/11/08.

To gain a larger sample size, I decided to look at the NDX, which historically has been more volatile. In this case I required a 2.5% drop (instead of 2%) and kept the other requirements the same – no closing 10-day low and a 14-period ADX below 20. With less historical data this test only ran back to 1986. Below are those results:



More of the same here.

Strong pullbacks in strong uptrends may be buyable. Strong pullback in consolidations, on the other hand, have historically led to more downside. Based on this study, caution seems warranted.