Blog | Quantifiable Edges | Assessing Market Action With Indicators & History

Everything Is Off The Charts

Posted by Rob Hanna in Uncategorized October 7, 2008

Most every indicator I look at with regards to breadth, volatility, and price action is strongly suggesting a strong short-term bounce should be at hand. Below is a short excerpt from Sunday night’s Subscriber Letter which puts some of my thoughts on these extremes into context.

What needs to be kept in mind is that the price action over the last week has been more severe than at any time other than 1987 and then back to the 1930’s. In other words, while extreme readings in breadth, volatility, price, and volume indicators of this magnitude have almost always led to short-term upside over the periods tested, the current situation is far beyond most everything tested. Measures need to be taken to control risk. Tight stops are a possibility, but difficult to implement with such extreme volatility. I’m controlling risk by scaling in with reduced position size.

An Elevated VIX Study

Posted by Rob Hanna in Quantitative Study October 6, 2008

On Friday the VIX closed above 45 for the 2nd day in a row. This is the 1st time since the VIX has been measured back to in 1990 that this has happened. Meanwhile the VXO closed above 50 for the 2nd day in a row. The only other time readings this high can be seen were in a back-adjusted 1987 period during and after the crash. I ran some tests to see how the market has performed the week following back to back readings above other extremely high levels:

While the instances get low over 40, average profits of greater than 5% over the next 5 days across the board are quite impressive.

Another Example Of Unprecedented Volatility

Posted by Rob Hanna in Quantitative Study October 3, 2008

Including Thursday there have been 18 days since 1960 where the S&P 500 has closed down 4% or more. Four of them have come in the last 3 weeks. The only other period to come close was the Crash of ’87 when it occurred on 10/16, 10/19, and 10/26. Of the previous 17 instances, the market finished higher the next day 14 times. All instances are listed below:

Recent volatility is tremendous, and this is just another example of it.

With such volatility comes opportunity. When looking to take advantage of edges during extreme periods such as this, traders need to make sure they are comfortable executing their plan. Otherwise they could end up as part of the panicked crowd. Trading while in a panicked state simply isn’t conducive to optimal decision making.

One last tip. Bailout news tomorrow could make for fast market conditions. Traders may want to place any stops they are planning ahead of the news. Otherwise execution may become difficult to impossible.

Strong Bounce, Weak Volume

Posted by Rob Hanna in Quantitative Study, reversal bar, volume September 30, 2008

A few weeks ago I showed how weak bounces have a tendency to quickly roll right back over. The good news is Tuesday’s bounce was far from weak. Tonight I decided to show a similar study examining strong bounces after a sharp move to new lows:

As you can see there tends to be an immediate and lasting edge when the bounce is sharp like we saw on Tuesday. There was a weak spot with Tuesday’s bounce, though – volume. It came in quite a bit lighter than Monday. Adding this filter changes the results to look like this:

While there is no negative implications in the first few days, the apparent lack of big buyers (volume) does seem to have a negative impact on returns after day 4.

Instances are a bit low, and many of them aren’t very comparable to current conditions. There’s a big difference between a rebound from a 2% drop and a rebound from an 8% drop. Therefore, I’d suggest the appropriate thing to do with this study is keep it filed for future reference. Then perhaps review some of the charts I posted last night.

The Crash Of 29…September 29

Posted by Rob Hanna in Quantitative Study September 29, 2008

The S&P 500 today lost 8.7%. That wasn’t the worst of it. The Nasdaq 100 lost about 10.5% and the banking index (BKX) lost 20%. For the S&P 500 there has only been 1 day that has been worse – 10/19/87 – the crash of ’87. On October 26, 1987 the S&P dropped 8.3%, which was close. Some other memorable drops since then would include 10/27/97 (-6.9%), 8/31/98 (-6.8%), and 9/17/01 (-4.9%). This was about 2% worse than any of those.

Using the Dow, I was able to look at similar drops back to 1920. Below are charts of all the times the Dow lost 8.0% or more in one day.

1929

1931-32

August 1932

1933

1987

A few observations:

1932 and 1987 were the only instances that were near a low.

In no case was a V-bottom like ’97, ’98, or ’01 formed. A sharp bounce was followed by either sideways or downward movement.

A sharp bounce occurred within 3 days in all cases.

1932 was the only time the day of the big drop came after an extended decline. In contrast, the crashes of 1929 and 1987 happened as a breakdown from a topping pattern.

Good luck trading.

What The Recent Gap Action Is Suggesting About The Intermediate-Term

Posted by Rob Hanna in Quantitative Study September 29, 2008

When the market consistently gaps by significant amounts overnight it suggests skittish and news-dependent behavior. During good times, the market is not highly news-driven. People are more comfortable holding overnight or over the weekend and are not as reactive. It’s during downtrends and near bottoms that market reactions to company and economic news and reports become more volatile. I decided to run some tests using the average absolute gap.

By measuring the absolute gap I did not factor direction into the equation. A large gap up is just as “reactive” as a large gap down. The 10-day average absolute gap is currently about 3 times as large as the 100-day average absolute gap. It peaked at nearly 3.5 times on the 19th. The only other time since the inception of the SPY that this ratio has been this high is after 9/11/2001. The study below looks at 20-day performance after different multiples have been achieved.

These results are suggestive of an intermediate-term upside edge.

1% Gap Down Stats Since The Top

Posted by Rob Hanna in gaps September 26, 2008

I looked at gaps lower of 1% or more since the bear market began last October. There have been 24 of them. Below are a few quick stats.

12 of 24 filled made it back to the previous day’s close at some point during the day.

14 of 24 finished higher than the open.

19 broke above the high of the 1st half hour. 10 made higher gains. 9 closed lower than the breakout. The average gain from breakout to close was 1.6%. The average loss breakout to close was 1.2%.

19 also broke below the 1st half hour of trading. 10 of them finished above the breakdown point and 9 below. The average gain of the risers was 1% and the average loss of the decliners form the breakdown point was 1.5%.

——————————————————

Also, Thursday was a follow through day for the market. Traders may want to review some of the FTD research over the weekend, including short-term implications.

Slowing Rate Of Decline Helps Bullish Case

Posted by Rob Hanna in Quantitative Study September 24, 2008

An interesting aspect of the recent pullback is that while the market has declined each of the last three days, the rate of decline has slowed. (SPX down 3.8%, then -1.5%, and now -0.2%.) I ran a test to study the significance of a slowing rate of decline. First I looked at a baseline test showing all returns after a 3-day decline under the 200 day moving average.

With the baseline set I added the condition that the rate of decline slow the last two days.

The decrease in the rate of decline appears to suggest that selling enthusiasm is waning. Implications are somewhat bullish when compared to typical three day pullbacks.

Gaps Stats And How The Lack Of Shorts Could Influence Action

Posted by Rob Hanna in Uncategorized September 24, 2008

With the gap up on Friday, the 10-day absolute average gap (size without direction) in the SPY peaked at just over 2%. As of Tuesday’s close the reading was down to 1.82%. Tonight as I type the futures are up over 1%, so expect another gap on Wednesday. The 2.01% average is a record. The only other time SPY cam close was after 9/11, when the 10-day absolute average gap hit 1.99%. It actually peaked on 9/24 when the SPY gapped up 2.5% after gapping down 4.74% the previous day (and over 8% down on 9/17 when the market re-opened).

Last winter I did several posts on playing gaps. Two of particular interest may be the large gaps up and large gaps down posts. In those I found that when the market was in a long-term downtrend large gaps in either direction had a tendency to lead to gains from open to close.

The upside edge for large gaps down was likely due to the fact that the move was an overreaction and the retail traders got fleeced. The sharp morning drop may have allowed a temporary panic bottom to form and the market to move higher as the day wore on.

The upside edge for large gaps higher often comes from the fact that the shorts just got trapped. They need to cover their positions and are forced to chase as the market moves against them. These bear traps have often come following a Fed or other government announcement. The massive gap up on Friday was engineered with perfect timing for a short squeeze since it was expiration Friday. Adam Warner did a nice job of explaining the impact of the timing in a recent post.

I’m most interested in watching reactions to large gaps up in the coming days and weeks. With their new rule prohibiting short sales in a large number of stocks, it would seem the government has taken away some potential explosiveness. If no one is chasing the gaps and bounces higher, the rally loses a good number of potential buyers.

In fact, the lack of short-coverers may partially explain the recent pullback. Volume has contracted greatly and the pullback has given back gains faster then any other. Under normal circumstances there likely would have been more volume and more support as the shorts that didn’t chase start covering when then market begins to pull back. With reduced explosiveness and less support, the elimination of shorts could actually make the bottoming process more difficult. At the very least it may change the shape of the bottom. It will certainly be interesting to watch and trade.

When The Market Does What The Market Doesn’t Do

Posted by Rob Hanna in Quantitative Study September 22, 2008

Some times when conducting historical analysis a small sample set can tell you that the market is doing something extraordinary. Indicators reaching excessive readings often suggest an edge because when things get too extreme, mean reversion tendencies tend to kick in.

There are other instances where a small sample set simply suggests the market is not acting as it should. Monday’s action may be a good example of this. Gains of 3% – 4% that occurred on Friday were given up Monday in all indices on an intraday basis and most on an end of day basis. The S&P 500 rallied over 4% on Friday. After dipping below Thursday’s close late in the day Monday, it barely closed above it. I ran a test to find other times since 1975 that the market had gained at least 4% one day and then printed a low below the close of 2 days ago.

Today was the first.

I loosened the requirements to 3.5%. Still nothing.

3%. Nope.

2.5%? Yes – two instances. Even at 2% there have only been 6 instances in the last 33 years where the market has given back all its prior day gains.

Now, in case you interested, all six of these did bounce above the selloff day’s close within 2 days. In fact, 5 of them managed to bounce the next day. The bounces did tend to die out after day 3. So perhaps there’s a small upside edge based on this study, but that’s not the real takeaway.

What’s significant here is that the market is acting in a way that it shouldn’t. It especially shouldn’t if it is planning on launching a great bull move. Look at some of the charts I’ve posted in the blog the last few days. Look at periods like March ‘03, July & October ’02, September ’01, September & October ’98, November ’97 and any other bottom you find. Massive one-day gains coming off lows simply don’t get wiped out the next day. It doesn’t happen. It happened Monday.

I would consider Monday’s action a warning sign.

If nothing else traders should still be operating under the assumption that the market environment remains extremely choppy. Look to take advantage of the chop. As an example, the incredibly simple system I published for shorting a few weeks back has had 4 trades since. Here they are (all trades based on SPX closing prices):

Short 8/27 – cover 9/2 – 0.32% gain
Short 9/8 – cover 9/9 – 3.41% gain
Short 9/11 – cover 9/15 – 4.43% gain
Short 9/19 – cover 9/22 – 3.83% gain

That’s 12% from just the short side in a little over 3 weeks. All based on an incredibly simple system. Playing the chop has been working. Monday’s action suggests that despite last week’s bottom attempt, this hasn’t yet changed.

Is The Lack of a CBI Spike a Bad Omen?

Posted by Rob Hanna in CBI September 22, 2008

I received an interesting question from a subscriber about the lack of action in the CBI and whether there have been successful bottoms in past that occurred without a spike in the Capitulative Breadth Indictor. With moves to 10 or higher in November, January, March, and July it would seem curious we only reached 5 last week.

While somewhat rare, there have been bottoms that did not see the CBI reading reach 7 or higher at any point in the downmove. The most recent was the May-June selloff in 2006, which peaked at 5 on the May leg down and only reached 3 on the June leg down. This can be seen in the chart below. The CBI is the indicator in the bottom pane. The S&P 500 is charted on top.

The March, 2001 bottom which led to a 2-month rally in the S&P had a CBI reading that peaked at 6. During the sharp selloff in October of 1997 the CBI only reached 4.

The one that might seem most similar to the current situation is October of 1998. After spiking huge in August (similar to July of this year), it hardly budged on the October leg down, peaking at 5.

While I don’t store intraday readings, I did notice on Thursday morning that had the market closed near Thursday’s lows it would have led to a CBI of 8.

In summary, I wouldn’t consider the lack of a high CBI reading a negative for the rally potential. I’ve found it most useful as a short-term indicator and not suggestive of long-term implications.

Big Ass Reversals

Posted by Rob Hanna in Quantitative Study September 18, 2008

The kind of price action we’ve seen in the S&P over the last two days has been found almost exclusively in one type of place – bottoms.

I looked at any time the market closed up by at least 3% today after being down over 1.5% yesterday. Both days had to have at least a 3.5% range. There was no criteria stating the market had to have suffered a significant selloff – but it always did. I don’t have charts of the 1st 3 instances. The rest I do.

The first was 10/24/62 and it led to a major bottom and an immediate rally. The 2nd was 11/26/63 and the story was pretty much the same there. A big rally ensued. The pattern also appear on September 5, 1974. That was the lone disappointment. The market made two more legs down before bottoming out a month later.

The next 6 instances are all shown below. I’d suggest studying them.

1987

1997

1998

2000

2001

2002

Top & Bottom Five Dow Performers Of Recent Slide

Posted by Rob Hanna in Uncategorized September 18, 2008

In January I showed how when the market bottoms, the most oversold large-cap stocks tend to outperform those large-caps that held up the best. The follow-up post showing the results of the January best and worst is here.

I decided to check the best and worst performing Dow stocks since August 28th, excluding AIG – which I wouldn’t dream of touching. Below are the results:

Money Market Mess

Posted by Rob Hanna in Uncategorized September 17, 2008

I keep my IRA account with a broker. On Tuesday night I had 3% of my portfolio allocated to options trades and 97% allocated to cash. Or so I thought.

Wednesday morning my cash suffered a 3% gap. In fact, my cash gets swept each night to the Reserve Primary Fund – a massive money market fund. They broke the buck Tuesday night and managed to fall to $0.97.

Here’s their excuse: “The value of the debt securities issued by Lehman Brothers Holdings, Inc. (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00PM New York time today.”

The full press release is here.

If you don’t want to read the whole thing, here’s the real kicker (for me anyway):

“Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption.”

My broker has now informed me that I will not be able to place any more trades in the account for the time being. They can’t be cleared if I can’t get the cash from the Reserve Fund. Awesome time not to be able to trade.

Tonight Reserve Funds posted a new press release. Two more of their funds broke the buck. The Reserve Yield Plus Fund priced at $0.97 and the Reserve International Liquidity Fund priced at an astonishing $0.91.

Here is a nice little excerpt from the Reserve Yield Plus Fund Annual Report dated March 31, 2008.

The cash entrusted to us is your reserve resource that you expect to be there no matter what. This is why we call ourselves The Reserve. Be you an individual, institution or a Fortune 500 company, this is your working capital to pay the rent, to finance inventory and receivables, to put food on the table. This is definitely not money to take risks with, and that is exactly how it should be managed.

We have been “accused” by some of asserting these tenets as if they were dogma to which The Reserve pleads: Guilty as charged. If one focused on the goal of effective cash management, the truths to accomplish it are self-evident and unequivocal, and reaching for yield while risking principal, liquidity or peace of mind is not among them…

…Thank you for your confidence in our Reserve. We never forget you have entrusted us with your reserve(s).

Bruce Bent
Chairman and CEO

Nice work Bruce.

I certainly hope these guys are the only ones dumb enough to invest money market assets in worthless paper, but I tend to doubt it. I would not be surprised to see a mass exodus out of non-treasury money market funds. I’m sure that won’t help those still trying to maintain the buck. There could be more carnage to follow. One result already is that everyone wants treasuries and they’re now at the lowest yield since at least WWII.

For information on opening an account with the Reserve Funds, click here.

An Interesting Pattern Of Strength

Posted by Rob Hanna in Quantitative Study September 17, 2008

After gapping down Tuesday morning the market put in a sizable rally. The S&P gained over 4% from open to close. I looked back at other times the SPY gapped lower and then gained over 3.5% from open to close.

The low number of instances means this is more “interesting” than “significant”. The pattern was fairly consistent as 5 of the 6 closed below the entry point within the next week before launching higher. The six instances occurred on 10/28/97, 10/15/98, 1/3/01, 7/24/02, 3/17/03, and 1/23/08. Some significant bottoms in that mix. The only instance that didn’t pull back within the next week was 10/15/98.