Tests Of Strength

A few weeks ago I wrote about the propensity of upside gaps of 2% or more to pull back at some point in the following few days. There are currently 2 upside gaps of 2% or more that have yet to close below the opening gap price. They are the 10/28 and the 10/30 gaps. It appears unlikely that the 10/28 level of $87.34 will be threatened in the next day or so. Should the 10/30 opening gap also hold that could be viewed as a significant sign of strength for this early attempt at a rally.

Another possible sign of strength will also be challenged in the next few days. In my August 28th post I showed a system that took advantage of the choppy, downward trading that had existed over the last year plus up to that point. Below are updated statistics of this simple system:

Sell short if the S&P 500 closes higher 2 days in a row. Cover on close below entry price – up to 4 days later. If still not profitable on day 4, close anyway. $100k/trade. June 1, 2007 – present.

Amazingly, the system has not triggered since 9/26/08. Therefore, the 48% profits generated were all achieved prior to the big October selloff. The system is also in an 18-trade winning streak, dating back to April.

The market is reaching short-term overbought conditions that over the last year and a half have led to at least short-term pullbacks. Whether it is able to rally in the face of such conditions or whether it pulls back sharply in the next few days could be a telling sign of strength or weakness, and whether a character change could be in order.