Low SPY Volume & Low VIX on Options Expiration
I was on vacation last week with limited access to the internet. While subscribers still got the nightly Subscriber Letter, I was unable to produce blogs. I’m back now and will have some edges to share this week. This is one study I found interesting from Sunday night’s Subscriber Letter.
Pretty much everything I’m looking at short-term is suggesting a pullback. Longer-term that is not the case.
What Happens After A Sharp Contraction In Volatility
I did a study looking at situations where historical volatility has contracted rapidly like it has in the last 3 days. For the study I looked at the 3-day historical volatility and compared it to the 10-day historical volatility 3 days ago. In other words I divided Friday’s 3-day historical volatility by Tuesday’s 10-day historical volatility. A result below 1 would indicate the last 3 days have been less volatile than the previous 10. A number above 1 would indicate a recent uptick in volatility. For the SPX, Friday’s 3-day over Tuesday’s 10-day came in at a very low 0.23.
I then looked to see what the 3-day historical volatility has typically been 3 days later. What does a sharp contraction over the last 3 days indicate you might expect over the next 3 days? What I found is that when the 3-day over the offset 10-day dropped to 0.25 or lower the next 3 days were 5.5 times as volatile as the recent 3 days. This is based on 1,111 trading days since 1960 – or about 9% of all trading days. Going back to just 1999 gave similar results, as the 3-day historical volatility increased by 5.4 times.
This suggests we may see some increased movement over the next few days. A breakout of the recent 3-day range could be very sharp.
Another Example of a Weak Bounce
My studies indicated a bounce was likely yesterday. It arrived, but unfortunately it was another example of a weak bounce. Below is a study that looks at SPY bounces from lows that lack volume.
(click to enlarge)
The only instance that did NOT post a lower close within 3 days was just 2 weeks ago – on 6/23/09.
A Couple Of Links Courtesy of the Quantifinder
I’ll try and get a new post up later. In the meantime, below are 2 studies the Quantfinder picked out yesterday from former blog posts:
1) 4 Lower Lows
Monday’s Disspoitning Bounce & What That May Suggest
Some technical problems this morning delayed my routine and didn’t allow me to post a fresh study before the market opened. I thought I would discuss a point I made in last night’s Subscriber Letter about the strongly bullish short-term study from Sunday night.
The indication was that following a day like Thursday, the SPY had closed up strongly over every 1 and 3 day period. Monday closed marginally higher in the S&P 500, although the SPY closed down 1 cent. Compared to the other 7 instances that were identified in the study, Monday’s action was the weakest. This can serve as a warning sign. When the market doesn’t rally as it is supposed to it may be suggesting a move in the other direction.
It may help some traders to think of such scenarios as they might failed patterns. Take a breakout for instance. When breakout from a triangle or other consolidation pattern fails, it can often lead to a sharp reversal in the opposite direction. The same concept applies to historical studies. When the market doesn’t do what it is supposed to, you need to reassess. Like any other type of analysis, historical analysis requires constant reassessment. The market isn’t static and your analysis shouldn’t be either.
A Rare Setup That Has Triggered Powerful Bounces
Thursday’s action was extreme in that the gap down was large and the SPY opened at its high and closed at its low. Often reactions this strong and persistent are overreactions. Overwhelming negativity such as this has led to quick, sharp, bounces in the past. Below is a study that exemplifies this:
1st Day Of Month Tendencies
The Stock Traders Almanac noted that the Dow Has been up 16 of the last 19 years on the 1st trading day in July. It’s been a while since I last looked at 1st day of the month tendencies.

Lastly I broke out the performance by month. You’ll note July has been the most reliable month over the last 22 years. It also ranks 3rd based on average profits. August has had the worst performance.
Low QQQQ Volume In an Uptrend Revisited
Friday night the Quantifinder identified the below study. I haven’t updated it in over a year so I thought it would be interesting to do so.
Results are much the same as they were a year ago. Low QQQQ volume in an uptrend has often signalled at least a short-term drying up of buying interest. Historically this has created negative expectations over the next several days and weeks.
Much of the net negative thrust has often been found in the 1st two days following the setup.
A Study Suggesting Short-term Downside
Below is a study that has been shown a few times in the Subscriber Letter. It popped up last night via the Quantifinder. It looks at what happens when two days of strong breadth fail to take the SPX to a new 10-day intraday high. I’ve re-run the stats and posted them below.
The failure to make a 10-day high after two strong up days suggests there was a strong move down prior to this. Most often the strong down move will reassert itself or at least cause a pullback. As a point of comparison, below are the numbers when the back-to-back the strength does coincide with a 10-day high:
Strong negative expectations turn positive under this scenario. I’ve shown before how positioning is important when interpreting action. This is another example of that.
Poor Rebound Breadth Not A Good Sign
Originally published in the blog on 9/11/2008, the Quantifinder noted the below breadth-based study for Tuesday’s close. I re-ran it in last night’s Subscriber Letter and have updated it below. (Note: Up Volume % is tracked in the members chart area each night. It is equal to (Up volume / (Up volume + down volume).
The fact that there was a pullback within three days every time is a fairly compelling stat. There have been 2 upmoves occur in the 6-day holding period since I published the first set of results last September. They both had pullbacks first though, allowing either opportunity for profit or at least a chance to move your stop to breakeven. Below I’ve listed all the trades along with their 6-day exit:
Father’s Day Fun With Pairs & ETF’s Rewind’s Tools
We spent Father’s Day at my in-laws. My father-in-law actively trades and a lot of what he does is pairs trading. He’s been getting more involved with pairs lately and comes up with some crazy ones. He does some testing on the computer but a lot of his testing is done “old school” with a pen and paper.
So I brought my laptop over armed with Jeff Pietsch’s ETF Rewind tool. As part of ETF Rewind, Jeff has one worksheet that is set up to do pairs analysis. I rarely see him mention it on his blog, but it is really a cool tool. You can put in any ETFs or stocks (or combination) and see how playing mean reversions following extreme divergences would have played out over the last 6 months. It comes with an optimization feature that allows you see how extreme the optimal settings are and what the best lookback period would be. Running an optimization takes about 15 seconds.
My father-in-law does swing trading so we focused on finding pairs that performed well with short lookback periods and less extreme divergences. He had a whole list he wanted to try out and we were able to zip through them and see which ones had potential and which ones didn’t.
The tool doesn’t do detailed system testing but it’s a great idea checker. So if you’ve thought about playing growth vs. value, or gold vs. gold miners, or even something crazy like AMZN vs. silver, it takes about 30 seconds to find out whether your ideas are worth exploring further, or whether you’re better off scrapping them.
Personally, what I like best about the tool is that it also seems to act as an idea machine. There’s really no end to the possibilities and the more you play with it the more ideas you end up wanting to explore. It also gives you a sense of what to look for when considering certain securities for pairs. Some securities seemed to work well with almost anything paired up with them while others struggled with all combinations. It makes you think deeper about the nature and tendencies of certain sectors and security types.
Anyway, enough from me. Check it out for yourself if you want. I know Jeff offers a 3-day free trial with all his subscription plans (yes – that includes Blogger Triple Play). Just make sure you spend some time playing with the pairs worksheet if you trial it.
A Dollar’s Edge
One relationship I’ve been watching lately is the S&P vs. the US dollar. To illustrate the relationship I’ve created a chart below. In red is the closing prices of the S&P 500. The blue is closing prices of UDN, which is the US Dollar Bearish Fund ETF.
As you can see they’ve pretty much moved in concert over the last year-plus. Since UDN is a bearish fund this means that the S&P has actually moved opposite the dollar. A weak dollar has been cause for celebration and a strong dollar has closely preceded most of the drops in the S&P.
But can the performance in the dollar provide a trading edge in the S&P? Below is the equity curve of an incredibly simple system. If UDN outperforms SPX on the day, go long SPX at the close. If UDN underperforms, go short SPX at the close. Basically you’re either 100% long or 100% short depending on how the dollar (inverse) performed that day relative to the SPX. For purposes of the test, no commissions or slippage are included.
That’s more than an 82% non-compounded gain over the last 18 months. This edge won’t last forever. Still, this should demonstrate that the correlation between the dollar and the S&P is important. Moves in the dollar have a definite impact on the S&P. S&P traders would be well served to monitor the dollar’s performance closely and on an ongoing basis.
Slowing Rate of Decline Potentially Short-term Bullish
Also notable about Wednesday’s action was that while the market has declined for at least 3 days in a row, the rate of decline has lessened both of the last 2 days. Back in September I found this pattern to have bullish consequences when the market was trading below its 200-day moving average. I decided to test it out when above the 200ma as well. I found that prior to 1987 there was no bullish influence based on the pattern. Since 1987 one has appeared. Here is the test using the SPY. First the base case without the slowing rate of decline requirement.
From A High to a Low in 1 Day
I noted in a tweet last night that big moves down are more short-term bullish when they aren’t occurring from a high. This was a bit of an understatement. They’re often short-term bearish. Yesterday’s drop moved the S&P 500 from a 10-day closing high to a 10-day closing low. Since 1960 there have been only 10 other times this has happened. In last night’s Subscriber Letter I show the results of those 10 instances.
To get a larger sample size I also reduced the requirements from a 10-day high and low to a 7-day high and low. Those results are below. (Click table to enlarge.)
These results suggest more downside, especially over the next 2-4 days.
For more discussion on big drops from highs you may want to review this former study.
P.S. I just noticed that Dr. Brett also looked at the 10-day high to 10-day low move this morning. See what he has to say here.