In Larry Connors’ book “How Markets Really Work” he devotes a chapter to “Up Days In A Row vs. Down Days In A Row”. He looks at how the market has performed after it has moved in one direction for 1, 2, or 3 days in a row. Because of the long-term upward drift of the stock market, very few of the studies published in the book show much of a negative tendency. One situation that showed a negative tendency over the following 1, 2, and 5 day periods was when the market was trading below its 200-day moving average and had posted three higher closes. (This happened today.)
The book looked at data from 1989-2003. Over that period the following results were shown:
I tested back 35 years and found the results to be similar. About a coin flip on direction, but downside risks were higher than upside rewards giving the next 1-5 days a negative expectancy.
This study on its own is not a reason to sell short. It should serve as a caution though for those holding long positions. Rallies during longer-term downtrends are not normally very persistent. Long-side traders will many times shorten their time frames while short-sellers use the bounces as an opportunity to add more short exposure – all causing a lot of backing and filling. Also note that two of the highest volume days of the last two and a half weeks were on January 31st and February 1st. A lot of people bought a lot of stock on those two days. They’ve been underwater ever since. After three up days in a row, the market has moved back into the middle of the range of those two days. We may see a lot of folks here that are relieved to be able to get out near breakeven on their purchases. This should create some additional selling pressure.
Seems to me like a good time to tighten things up on the long side. Aggressive traders could consider taking a shot short here soon if they’re able to find a favorable entrypoint.
Rob Hanna
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