I remember a riddle from when I was a kid that went something like this:

Q: If a rooster lays an egg right at the very peak of the roof of the barn while facing north and the roof slopes east and west, which way will the egg roll?

A: It won’t. Roosters don’t lay eggs.

Now for the market:

Q: If the S&P shoots up 2.5% or more in one day and then closes within 0.5% of its closing price the next five days in a row, which way will the market break?

A: The S&P doesn’t do that…until now.

Here’s a line chart of the S&P 500.

With the 1st quarter behind us I thought a summary of what we learned on the blog through the studies would be interesting. (You should also note that most of these studies are now available in the 1st Quarter 2008 Quantifiable Edges Studies Package for Tradestation users.)

If the VXO spikes higher and the market doesn’t rebound…look out below!

Some kinds of reversal bars really do work. And so do others.

IBD Follow Through Days provide an edge – but it’s not as advertised. (FTD’s are not included in the 1st Quarter Studies Package but will be separately available soon.)

When time gets stretched, price reversals are typically close at hand.

When capitulating markets bounce, it’s the most beat up stocks that bounce the highest. (Not included in Q1 package -study done outside of Tradestation.)

When the Nasdaq and Russell get disjointed it typically means volatility and rising prices.

Large gaps in downtrends should be bought. Both down and up. (Not included in package – done mostly outside of Tradestation).

Big Arms can lead to next day buying.

Inside Days have a tendency to lead to short-term downside.

Some contracting ranges suggest more upside.

3 up days in a downtrend tend to lead to selling.

Failed gaps aren’t as bad as they seem.

Triangle breakouts are highly unreliable and may provide an edge to fade.

A late surge may or may not carry over to the next day.

Not all breakouts are good.

Nasdaq Leadership can be important.

There is a recent edge on the 1st trading day of the month.

Four months lower doesn’t mean we’re going up.

More proof reversal bars work.

Put/call ratios can help signal a reversal is near.

Stretched VXO readings are generally a short-term positive for the market.

New low divergences are nice but not overly positive.

Strong moves off bottoms can lead to intermediate-term rallies.

Sharply declining consumer sentiment tends to precede stock market lows.

Fed rallies tend to be short-lived.

Overbought in a downtrend can lead to some nice shorts.

Light volume on a pullback isn’t necessarily positive.

The market doesn’t get marked up on the last day of the quarter.

And a few more.

In all, there are 45 studies included in the Quantifiable Edges 1st Quarter package. At a time when programmers charge $100 – $150/hr, I’m offering the entire package for $195. That’s about $4.33 per study. All open coded. Flexible inputs for further research. Ready-to-import data files for those studies that need it (like the Consumer Sentiment Index study). If you want to test you own ideas in Tradestation, this group of studies can also provide some nice templates to work with. Click here to purchase and you can download and import the studies and workspaces into Tradestation in just a few minutes.

I’ll bet the 2nd quarter teaches us just as much as the 1st…

With all the recent volatility in the market, many traders have noted the recent low VIX levels and wondered if that was a sign of complacency. Low VIX readings relative to their short-term moving averages do sometimes presage market pullbacks. While one use of the VIX is trying to predict the direction of the market. That really isn’t what the VIX represents. It represents options traders perception of future volatility. So perhaps the low VIX means they know something?

One of the most unusual aspects of the recent environment is how volatile it has been in a virtually trendless market. Wild swings within a range. Lots of chop. To quantify this action I took the 14-day ADX of the SPX (15.56) and divided it by the 14-day historical volatility (volatilitystddev in Tradestation terms), which currently stands at 0.3023. The result (about 51) is what I call trend over volatility (TOV). Charting this helps to see other times where volatility was high and the market wasn’t trending.

Going back to 1960 I was only able to find 5 other periods where the TOV was below 55. Looking at the performance of the market “X” days out gave the following results:

Four pretty strong winners and one sizable loser. Interesting, but perhaps not compelling enough for a directional bet on its own. (Combined with my other recent studies it may be.)

To try and glean a little more I looked at the charts. The top line is TOV. The yellow line is ADX. The blue line is Historical Volatility. The vertical line shows when the TOV dropped to 55 or lower. (Click charts to enlarge.)

October 2002

February 1999

January 1988

October 1987

The one thing that stuck out to me? In every case, at some point in the next month there was a sharp drop in historical volatility. In ’87 and ’88 it took about 3 weeks. The other times it was almost immediate. Does the VIX know something? It just might.

Perhaps those uncomfortable with directional bets in the current market might prefer to use options and bet on a reduction in volatility.

I haven’t done too much with this indicator yet, but I suspect it could have applications for individual stocks as well.

I’ve had the pleasure of doing some work with and for Larry Connors. His ideas have inspired a good amount of the work I’ve done over the last several years. I’ve mentioned before his book “How Markets Really Work”, which has many interesting facts and observations in it. When I went to the TradingMarkets site today I noticed they were allowing free downloads of the book until Monday night. I’d highly recommend people download and read it. Here’s the link:

How Markets Really Work

Today’s action didn’t appear spectacular in any way. The market consolidated its gains on ho-hum volume. While my blog yesterday indicated Tuesday’s big gains served as further confirmation that the market was likely to continue higher for at least a few weeks, the short-term is not as bullish. Most of the time there is some brief give back after such large moves.

I ran some numbers tonight looking at action immediately following up days of 3.5% or more in the S&P 500. Of the 35 instances since 1960 that my scan found, 31 of them traded lower than their thrust day close at some point in the next 5 days. (Make that 32 for 36 after Wednesday.) 18 of the 35 traded lower by 1.75% or more.

What’s this tell me? The pullback today was normal. In fact, continued pullback would be normal. The last two big thrust days (3/11 and 3/18) the market fell hard and fast almost immediately. If the market can get through tomorrow without a sharp selloff, that could be a positive. It would be a change in character.

I ran several different studies tonight all of which told me basically the same thing…nothing. From a short-term perspective I am not seeing much in the way of an edge. Let me quickly illustrate why. Below is a 60-minute chart going back to January.

Seems like a lot of movement to go nowhere. The market is right smack dab in the middle again. Rather than try and pick sides here, I’d prefer to wait for a clearer edge.

One notable about tomorrow is that it is the 1st day of the month. Since 1995 the first day of the month has been profitable about 2/3 of the time. (Before that there was no discernable edge.) More details on “1st day of month” can be found here.

I have several new things in the works right now, including a volume study that I hope to complete and release in the next week or so. As some of you may have noticed, I am now making the studies available for Tradestation users to purchase and download. By sometime this weekend I hope to have nearly all studies for Q1 available. I will be offering packages of the studies so that people may either examine the ideas further or use them as templates in conducting their own research.

The market has now sold off for two straight days. Of some concern is that I’m not seeing evidence that anything is overdone to the downside. For example, I looked at all stocks in the S&P 100 tonight along with my list of 115 highly liquid ETF’s that I track. None of them made a 10-day low on Thursday. None. Breadth is not suggesting we are due for a bounce.

Price-wise we are back to the middle of the recent range. I have very little to add tonight so I thought I’d do a quick review of outstanding studies. Earlier this week there were several bearish studies which had short-term influence. That influence is beginning to dissipate. Those studies may be found here and here.

Prior to these I had posted several bullish studies with intermediate to long-term influence. Each night in the Subscriber Letter I list all outstanding studies, their time frame and their bias. I find it a useful graphic for helping me organize my thoughts and determine my own trading bias. The bullish intermediate-term studies I consider active are listed below along with the time-frame they looked at.

March 24, 2008 Nasdaq Leadership Bullish – 1-10 weeks
March 19, 2008 Bottom Explosion 2 – 1-20 days
March 19, 2008 3.5% Up Cluster – 10-20 days
March 17, 2008 Consumer Sentiment Stretch – 1-12 months
March 12, 2008 Bottom Explosion – Now What? – 1-20 days

In reviewing them you may notice that many are just beginning to reach their sweet spot.

While the pullback may or may not have farther to fall I am not seeing evidence at this point that it will be anything more than a pullback.