The current action is bullish, here’s why…
Traders and investors are entitled to a bit of chiropractic care after the
market action we’ve seen thus far in 2006. We rose over 2% in the S&P
500 Index during the first six sessions of the year and then dropped over 2% in
the most recent six sessions. Only those in the oil patch seem to have
been spared the whiplash of the market’s roller coaster, avoiding Friday’s
steep, high volume drop.
I spent time over the weekend investigating historical precedents for the
action we’ve been seeing to determine what we might expect next. Details
of several of my investigations are available on my free
research website. Below I include one new set of findings and the most
outstanding conclusion from those earlier studies in hopes of preparing traders
for what promises to be an eventful week ahead.
My first conclusion is that volatility begets volatility.
Friday’s drop in the S&P 500 Index exchange traded fund
(
SPY |
Quote |
Chart |
News |
PowerRating) came on double
the average volume from the previous 60 days, falling 1.82%. Going back to
January, 1998 (N = 2022 trading days), I found 36 occasions in which SPY dropped
by more than 1.5% on volume that exceeded the 60-day average by 75% or
more. Those 36 occasions did not show a distinctive directional bias: they
were roughly evenly divided between up and down occasions over the next 1-3
days. They were, however, highly volatile occasions. The high-to-low
range for days following the high volume steep drops averaged 3.2%, double the
1.6% average for the sample overall. Indeed, 32 of the 36 occasions
displayed high to low ranges exceeding 1.5%. This volatility tended to
carry over beyond a single day, especially when the sharp, high volume drop was
followed by further weakness. The implication is that our roller coaster
ride has probably not ended.
My second conclusion is that roller coasters tend to be bullish.
My study takes an even longer-term look at the market since January, 1990 (N =
4043 trading days) to sort out performance under bull and bear conditions.
I examined all occasions in which the market had dropped more than 2% over the
past six trading sessions after having been up more than 2% in the six sessions
prior to the decline (N = 123). I then explored what typically happened
over the next six trading days. It turns out that such a configuration has
had quite a bullish bias. Following the up/down roller coaster pattern
(six days up/six down), the next six days averaged a gain of 1.02% (80 days up,
43 down). This is considerably better than the six-day average gain of
.22% (2273 up, 1770 down). Since the bull market began in March, 2003,
we’ve had seven instances of the roller coaster pattern. The market has
been up by an average of 1.77% over the next six days, with all but one of the
occasions sporting gains. Roller coasters of the up/down variety thus have
a bullish bias over a six-day horizon–a tendency that I found to be especially
pronounced during bull market periods, such as we’ve had recently.
The investigations on my site found that, as one might expect, near-term
market performance following a single high volume sharp decline depended very
much upon whether or not we are in a bull or bear market. In bull markets,
institutions treat large declines as opportunities for bargain hunting. In
bear markets, high volume, steep declines tend to cluster, creating significant
expansions of market volatility. Perhaps the most important conclusion we
can draw from the current market action will lie in the days ahead, as we see
whether investors treat the decline as opportunity or crisis.
Either way, it looks like we’re in for a ride.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance.