SPY failed to make either a higher high or a lower low than the day before. This is often referred to as an “inside day” because the range was completely inside the previous day’s range. In the past I have shown how inside days under the 200ma have often been followed by moves lower. What’s interesting is that while that held true for a long time, since the bottom in 2009 it has not been the case. Let’s first look at an updated results table based on this setup.

As you can see the statistics still appear bearish, with the downside edge basically playing out over the 1^st 3 days.  But now let’s take a look at the profit curve.

As you can see over the last two years (and 15 or so instances) the setup has not provided a downside edge.  Both the 1-day and 2-day profit curves looked very similar to this. 

It is important to understand when historical instances provide a directional edge.  But the market is always evolving.  And sometimes setups that provided an edge for a long time will either stop working or will go a period of time without demonstrating the same tendency.  It is important to monitor not only how has a setup performed over the long term, but also keep an eye on recent instances to ensure that edge is still being provided.  In this case it doesn’t seem to be.

The fact that the 10-year bond rates hit new highs on Thursday along with the SPX is notable. The study below is one I’ve published in the subscriber letter before.

Generally it seems that higher interest rates have often made bonds an attractive investment. This may lead people to forsake stocks in favor of lower risk returns with improved yield. (Not sure this will be the case this time with yields still so low.) Implications of this study appear to be longer-term in nature than we usually see. To help visualize how this edge has played out over time I have pasted the equity curve using a 50-day exit strategy.

This one looks very similar to the 20-day exit strategy. In this case the downside edge didn’t begin to exert itself until the 1970s but it too has persisted lower for a long time.

I’m starting to see a number of indications that the market is ripe for a pullback. One indication I noticed yesterday that will often suggest a pullback was the extremely tight range. Tight range can be a sign of indecision. When it occurs with the market extended upwards it can also imply the bulls are running out of gas and likely to step back for at least a short time. The study below demonstrates this concept.

Much of the edge here is realized within the 1st 2 days. If the market is going to act on this signal and flounder  it will often do so rather quickly.

One of the most important and largely ignored aspects of market analysis is putting the pattern or indicator readings you are examining into proper context. Is the market in an uptrend? A downtrend? At new highs? At new lows? It can make a big difference in how the market will react to setups.

Currently the SPX is bouncing strongly off of an intermediate-term bottom. Initial thrusts from bottoms are often much riskier to short than similar thrusts in downtrends that don’t originate off a bottom. I’ve shown many examples of this in the Quantifiable Edges Subscriber Letter. Below is an example that simply looks at 3-day rallies in downtrends. The 1st set of results looks at times where the rally originated from somewhere other than a 50-day low. The 2nd set require a 50-day low.

Here’s the 1st set:

Results here appear solidly bearish.

Now let’s look a times like the present where the market is emerging from an intermediate-term low.

These results appear to be a polar opposite of the previous set. It has been quite a hot streak since 2001 with these setups. Prior to that no edge was evident in either direction, but it still wasn’t bearish like the 1st setup.

Always keep context in mind, and don’t get too aggressive shorting thrusts off bottoms.

Tuesday happens to be the most likely day of the week for a turnaround.  I first examined this in the 1/13/09 blog.  With the last 2 days being heavily lopsided to the downside the odds of a turnaround on Tuesday are even higher.  This is demonstrated in the study below.

All the stats heavily favor a rally on Tuesday, and if not Tuesday, then Wednesday.  Perhaps the bulls can win a day or two here. 


Of course the current environment is a bit more extreme than most of the sample…