Quick Stats On Massive Gap Opens

Posted by in gaps, Quantitative Study September 8, 2008

It’s Monday morning and the futures are up over 3.0% due to the FNM/FRE bailout news. Since 1998 there have been 16 times when the S&P 500 has gapped up 2.0% or more. Eight of those times it closed higher than the open, and eight it closed lower.

Of the 16 instances 10 saw an intraday drop of 1% or more from the opening price and 6 did not.

12 of the 16 broke below the lows of the 1st half hour of trading at some point during the day. Shorting that break and holding until the end of the day would have resulted in 6 winning trades and 6 losing trades.

5 of them broke the lows of the 1st half hour after 10:30am. Of those, 4 went on to close even lower on the day. The lone instance that rebounded closed almost 3% higher, though.

So far I’ve yet to indentify a sizable edge for trading a gap this large on an intraday basis. I will update further if I do.

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Downside Acceleration Frequently Precedes Reflex Rallies

Posted by in Quantitative Study September 4, 2008

When a move that is already becoming extended rapidly accelerates it frequently means a countermove is about to begin. I discussed this concept in April in the context of an intraday timeframe. Tonight I will finally show its historical effectiveness using daily bars.

After trading lower for three days in a row, the S&P 500 (and most everything else) completely collapsed today, finishing down about 3%. Below is a study that shows the short-term statistics following similar setups:

The edge erodes after the 1st week. It’s basically a short-term setup. To give some perspective on how often any kind of bounce above the entry occurred I ran a 2nd study that looked to exit any time the trade closed profitable.

Pretty impressive reliability. Here we see 81% winners within the next 2 days, 89% within a week and 96% within 8 trading days.

Today’s drop was not only the biggest of the move down, it was over twice the size of the next biggest drop (last Friday). Generally, the more extreme the drop in comparison to the other days, the better the results. Below are the stats associated with a 2x drop similar to today:

Better winning percentage, higher average wins and lower average losses make for better overall stats. I also ran the “1st profitable exit” strategy here:


Thirteen of fourteen were positive within 3 days. By day 8, all fourteen instances were positive.

This all suggests a reflex move higher is likely in the next few days.

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Good Breadth On Down Days Is No Silver Lining

Posted by in Breadth, Quantitative Study September 4, 2008

Haven’t done any mythbusting in quite a while.

Wednesday saw the S&P 500 fall while advancing stocks outnumbered declining stocks. This is the 2nd day in a row this has occurred. Most people will tell you that positive breadth readings on down days suggest bullish implications. I decided to look and see what happened following back to back days of good breadth and lower index prices since 1970.

You could interpret the study as negative. You could interpret the study as a mild underperformance of long-term drift. You could even say it’s basically neutral. Bullish though? I see nothing bullish in the above numbers.

I also looked at performance following single days. It wasn’t much better and still underperformed the long-term drift of the market. Positive breadth on a down day should not be considered a silver lining.

Welcome back Adam and Jamie…

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Even In A Bad Market – Chop Has Provided Short-Term Upside Opportunities

Posted by in System, Trend Vs. Chop September 3, 2008

Last Thursday I showed an incredibly simple system with outstanding performance over the last 15 months. It basically sold short any time there were 2 up days and looked to exit at the 1st profitable close on or before day 4 – at which time it would exit no matter what. Incidentally, today’s drop would’ve been yet another winner for the system.

It’s not terribly surprising that a short-selling system has performed well over that time period. Fairly amazing is how a long-oriented system based on the same ideas can output numbers nearly as good. Below are system criteria reminiscent of last week’s studies:

Entry criteria:
1) The S&P closes lower two days in a row – buy on close.

Exit Criteria:
1) If the S&P closes above the entry price of the trade, sell on close. 2) Sell on the close of day 3 regardless of profitability.

Time Period: 6/1/2007 – present

Results – There have been 39 trades, 35 (90%) of which were profitable. The average trade made about 0.65%. Total profit over the period about 25.5% All trades are listed below:

Once again I should note that this system is a product of the environment and not a well-designed trading system. Entry and exit techniques are too raw for actual decision making.

That said, results were fairly impressive. There have now been 16 winners in a row going back to February and the market has seen a difficult time during that period.

Now that we’ve had two down days it’s likely a poor time to try and jump to the short-side. Those that are already short may want to consider taking profits. Traders could also begin thinking long in the next day or so.

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What If Volume Doesn’t Return?

Posted by in Quantitative Study September 1, 2008
So the general consensus is that the traders will return from vacation on Tuesday and volume will come back. But does volume always return after Labor Day? What if it doesn’t? I studied it tonight:
The study above suggests negative consequences should Tuesday’s volume not surpass Friday’s. The sample size is quite small, though and there have been no occurrences since 1994. Therefore I decided to widen the parameters. In this case I’m looking for instances where post Labor Day Tuesday volume doesn’t manage to exceed all of the days the previous week.

More instances. Similar results. The bulls should hope traders make a quick return from vacation Tuesday. Otherwise, September could be a difficult month.
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Clues The Market Character Could Be Changing

Posted by in Breadth, Quantitative Study August 28, 2008

The market rose strongly on Thursday. NYSE advancers outpaced decliners by over 3 to 1 – the 2nd day in a row advancers accounted for over 70% of the total. I’ve noted a few times recently that rallies in the S&P 500 since the end of May have been quick to reverse. Most have not lasted more than 2 days before suffering a down day. There have been three 3-day rallies and none of four days or longer. The market has now closed up 3 days in a row. We are reaching the upper boundary of “normal”. Although I’m not betting on it, traders should be on alert for a change of character in the market.

The market may or may not pull back in the next day or two, but it appears likely to happen quite soon. Back to back days of 70% advancers are fairly rare. The fact that it happened without the S&P 500 posting a 10-day high is even more unusual. Since 1970 this has happened 20 times. Sixteen (80%) of the time the market closed below the close of the trigger day within the next four days. If you give it 10 days to work off the overbought breadth readings then 19 (95%) of the time you’d find a close lower than the trigger day. In other words, a pullback appears likely in the not-too distant future.

I believe one key to determining whether the market character is possibly changing and a new leg higher possibly beginning will be the action on this pullback. This is the 7th rally of 2-3 days since July 21st. The previous six saw a decline of at least 1.2% on the first day of the pullback. That’s not orderly and not really what you want to see. In fact, other than the July 21st 1-day mini-pullback the last “orderly” pullback that didn’t involve a sharp drop occurred on the last 3 days of April.

Seems to me it might be a good time to be thinking about taking some short exposure. If the pullback is orderly, you can flip to the long side. If the pullback is sharp like the rest have been, it could mean a nice, quick, short trade.

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A Short System For Handling Chop

Posted by in System, Trend Vs. Chop August 27, 2008

In my recent Trend vs. Chop series I showed how over the last 15 months or so the market has become more prone to chop and less prone to follow-through. Tonight I will show an incredibly simple system that would have fared exceptionally well over this time period. I’ll then discuss the possible value of such a system.

Entry Criteria:
1) The S&P 500 closes higher 2 days in a row AND
2) The S&P closes below its 200-day moving average then sell short on close.

Exit Criteria:
1) If the S&P closes under the entry price of the trade, cover on close OR
2) Cover on the close of day 4 if not profitable.

Time Period: 6/1/2007 – present

Results:

There have been 26 trades, 25 (96%) of which were profitable. The average trade made about 0.75%. They are listed below:

If you relax the entry criteria and don’t require the S&P to close below the 200ma, then there will be 43 trades – 41 (95%) of which were profitable.

Some thoughts:

Although the performance has been stellar over the last 15 months, this is not a great system. In fact, if you run performance back to 1960, it’s not even a winning system.

I’m not a fan of the exit criteria. It keeps winners small. With a little effort I’m sure traders could come up with a more profitable exit strategy – even if it meant suffering a few more losing trades.

The bottom line here is that the market has been especially choppy over the last 15 months. Once aware of this, traders should look to take advantage. Seeing the market move in one direction for even a couple of days should alert traders that they may want to take profits or consider a strategy to benefit from a swing in the opposite direction.

Lastly, this environment will certainly change. While the above system may not be a great “trading” system, it does appear to be a very useful “tracking” system. In other words, moves higher of 2 days or more have quickly reversed and provided the system a nice string of winning trades. Traders should be on alert for system failures, as they could be a sign that selling into up-moves may be falling out of favor and the market environment changing. Therefore they would need to adjust their approach to take advantage of the new, emerging environment.

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Weak Bounce Is Not Encouraging

Posted by in Quantitative Study August 26, 2008

After the market suffers a sharp drop as it did Monday, the size of the bounce the next day can tell you a lot. A strong bounce may lead to further upside. Weak bounces often roll right back over. I plugged a 1.75% drop and a next day recovery of less than ¼ of the drop into the Wayback Machine tonight. Results below:

I have nothing good to say about these numbers, so I won’t say much.

Notable but not included in the table is that 77% of all instances closed lower at some point in the next three days. The average max drawdown for all trades over the first three days was just over 2.0%.

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Trend Vs. Chop III – Weekly Bars

Posted by in Quantitative Study, Trend Vs. Chop August 25, 2008

Last week I looked at trending vs. chopping tendencies for the market in both the daily and intraday timeframes. What I found is that in both time frames the market has evolved from trendy to choppy over time. Today I am going to look at weekly bars. I will also have some further follow-up later this week which look at the statistics of some of the “Trend vs. Chop” results.

I’m going to use the same “system” as last week to display weekly tendencies. The first test here buys on the close of any up bar and reverses to short at the close of any down bar. Like last week, the trades were at a constant $100,000 per trade for the entire period. No commissions or slippage are figured in to the test. A rising graph would indicate follow through is dominant while a falling graph would indicate reversals are dominant. Sideways action would suggest no tendency.

Unlike the daily and intraday time frames, which favored trendiness through much of their history until fairly recently, the weekly timeframe has been more prone to chop since the early 70’s.

As I did last week, let’s now break that down into upside follow-through and downside follow-through. You’ll see a large difference here. The chart below looks at the results of shorting down weeks.

In the bear market of the early 70’s this was profitable as the market tended to show persistent weakness. Since then, with the exception of a few short periods during bear markets, buying the dips has worked quite well.

Now let’s look at what happened if you looked to buy strength:

Upside follow through was strong through the 60’s and until January of 1973. That is where you see the peak near the left hand side of the graph. Since that time the market has gone through cycles that sometimes favored buying strength and sometimes favored selling strength. Thirty-five years later the equity of the system is right back near its peak 1973 level. It should be no surprise that the current spike down began in 2007.

These results shouldn’t come as much of a surprise to people who have spent time evaluating or developing swing-trading systems. When trying to take advantage of 3-5 day moves, it is generally easier to develop long-only strategies that perform relatively well over time than to produce short-only strategies that perform consistently well. Hence a big reason you see so many more long-only systems. Of course in 2008 so far shorting strength has been easier than buying weakness.

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MarketSci’s Take On Recent Studies

Posted by in Uncategorized August 25, 2008

One relatively new blog I’ve begun to read and enjoy is MarketSci. Over the weekend I decided to check out some the past posts and studies on his blog. I was surpised to find one post eerily similar to my own Trend vs. Chop study that he published in July. Michael’s findings agreed with my own with some additional twists. He also looked at results above and below the 200-day moving average, and he looked at bonds as well.

I’ll be expanding the study again and publishing some results based on weekly bars a little later.

MarketSci also had an interesting post last week which expanded nicely on my recent SOX studies suggesting the SOX can act as a leading catalyst for the broad market.

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Trend Vs. Chop For Intraday Traders

Posted by in Intraday, Quantitative Study, Trend Vs. Chop August 22, 2008

Yesterday’s post looked at the propensity of the market to chop vs. trend. The basic conclusion was that the market has shown less tendency to trend and more tendency to chop over the last few years. This was especially evident when looking at a long-term chart.

Today I’m going to show the tendencies on an intraday basis. The break down will be similar to yesterday. The first chart shows results of buying any up bar and then exiting on any down bar. 15 minute bars are used for all the tests below.
A rising graph would show a propensity to follow through and a falling graph would show a propensity to reverse. A flat graph wouldn’t favor either. One note about all these graphs is that the day is closed out flat. There is no overnight holding since we are only measuring intraday tendencies. Throughout most of the 90’s, the easiest way to make money intraday was to find an uptrend an jump on it. As with daily bars, that seems to have changed over the last several years.

What about shorting down bars? How has that worked?


Similar to buying strength, shorting weakness worked well in the 90’s. Over the last few years it has struggled. Even with the difficult stock market performance this year, downmoves have shown a higher propensity to reverse than to continue. The May-June period was a notable exception.

Now for the combination. The rules are basically the same as yesterday buy on an up bar and then reverse and short on a down bar. Again – no overnight holding since intraday trends are the issue.

No surprise here –trending behavior was favored until around 2003 when the market shifted to a significantly more choppy environment. The most pronounced choppiness has occurred in the last year and a half, suggesting the last year and a half has rewarded intraday reversal trades and punished intraday trend trades more than any time in the last 15 years.
Now for the long-term look back. For this test I was able to run the data back a little over 25 years.

As was seen with the daily bars yesterday, the propensity to reverse rather than trend is a relatively new phenomenon. Intraday traders would do well to consider the consequences of these tendencies when developing intraday strategies.
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How To Trade The Choppiest Environment In 50 Years

Posted by in Quantitative Study, Trend Vs. Chop August 21, 2008

If you trade trend or breakout strategies and have found the market difficult in the last year or so, I’m about to show a prime reason for that diffuclty. Below is a strategy that buys the S&P 500 on the close of any up day. The position is closed at the close of a down day. Essentially your looking to buy strength and sit out weakness.


This strategy worked well in the 90’s, but since the market topped in 2000, it has performed poorly. Since the Spring of 2007 it has really accelerated lower. What this means is that performance following up days has been especially bad. It suggests the environenment has been especially choppy. Whereas strength begat strength in the 90’s, it has led to immediate weakness since.

Now let’s take a look at downside follow through. In this case the strategy is to sell short on any down day and then cover on an up day.


This was a break-even strategy through July of 2002. Since then it has done terrible. Interestingly, it’s done especially bad over the last year plus. Even though the market has fallen precipitously, the manner in which it has occurred has made it difficult to profit if you’re trying to short breakdowns. Down days have been followed by up days.

What about a combination strategy? Buy strength and short weakness in anticipation of further follow through. Below is a chart with the combo strategy:

Again, since March 2007 this strategy would have experienced an incredible freefall.

Perhaps it would be best to take a step back, though. In the next chart I show back to 1960 instead of 1993 in an effort to find other periods where choppiness has been so prevalent.


As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. This would suggest that strategies that may have worked well for forty years or more could be suffering greatly now. Traders should consider the current choppy market behavior when designing strategies. Buying weakness and selling strength is working better than buying strength and selling weakness. They could also monitor charts like these to see if tendencies begin to revert back to pre-2000. If tendencies do revert, adjustments may be needed.
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Update: I just saw that Dr. Brett Steenbarger also addressed this topic in his blog today. He looked at it from an international standpoint as well. Click here to see his findings.
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Potential Bad Breadth Bounce On Tap

Posted by in Breadth, Quantitative Study August 19, 2008

The selloff from Monday followed through on Tuesday. For the second day in a row declining stocks outpaced advancing stocks by nearly 3:1. Also notable is that even with 2 days of strong selling the S&P failed to close at a 10-day low. I ran these observations through the wayback machine tonight and came up with the following results:

Instances are a bit smaller than I typically like but the stats are impressive enough for me to take the study into consideration.

A few additional bits of information about the study:
1) 12 of 14 instances (85.7%) closed above the entry day close within the first week.
2) If you look out 7 trading days that improves to 13 of 14 (92.9%).
3) The average maximum gain over the next 12 days is 5.2%. The average maximum drawdown is 2.2%.
4) After 7-12 days the edge dissipates. The setup is only short-term in nature.

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An Instance Where Light Volume Pullbacks Don’t Provide Bullish Expectations

Posted by in Quantitative Study, volume August 18, 2008

Normally light volume on a pullback can be regarded as a good thing. When the pullback is fairly large and the volume is extremely light the expectations can turn bearish. For instance, the S&P dropped about 1.5% today on the lightest volume since July 3rd. I loosened the parameters slightly to get a decent sized sample and ran a study:

Of course volume this week and next week are expected to be a bit lighter due to traders taking vacations. Still, I don’t find the results terribly encouraging for the bullish case over the next two weeks.

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