These stats hint at the market’s next move
The S&P 500, as tracked by SPY, has been up for five consecutive weeks.
Does this mean we should be trend followers going forward, or is the market
overbought and ripe for decline? The answer to this key question is a bit
complicated.
From February, 1996 to the present (N = 502 weeks), we’ve had 23 occasions in
which the market has been up five weeks in a row. Following those 23
periods, the market has gained an average of 1.11% over the next five weeks.
This compares favorably with the average five-week gain of .75% during this
period.
These averages mask some important distinctions, however. From
1996-1999, there were 10 instances in which the market was up five weeks in a
row. Nine of those occasions resulted in higher prices five weeks later,
by a whopping average of 3.98%. Clearly it would have paid to have been a
buyer after five consecutive weeks of strength. But after the last five
instances in which the market has been higher five weeks in a row, dating back
to September, 2004, the market has been down five weeks later after all five
occasions. The market was behaving as if it were overbought.
What has happened is that a momentum market in which strength followed
strength (the late 1990s) has given way to a reversal regime in which strength
begets weakness. Looking at broad historical averages can mask such
important shifts. The current strength, from that perspective, is not
necessarily an intermediate-term plus for the bulls going forward.
But let’s take it from a different angle. The market
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been up for seven consecutive trading sessions as of Friday. What has
typically happened after such a run? From January, 1996 to the present (N
= 2454 days), the average seven-day change has been .24%. We have only
seen 13 runs of seven consecutive up days during that time. Over the next
seven days, the market has been up only twice, down 11 times, for an average
change of -1.34%. From 1997 through 2000, the market was up twice, down
three times after a run of seven consecutive winning days. From 2001 to
the present, the market has been down on all eight occasions that we’ve enjoyed
such runs.
Let’s say, however, that we widen our net and look at occasions when the
market has been up at least six of the last seven days. This gives us a
larger sample size (N = 131 days). Here we see that, after six or more up
days, the market’s next seven days average -.14%, well below the .24% for the
sample overall. From 1996 through 1999 (N = 47), the seven days following
such strength returned .29%. But from 2000 to the present, the next seven
days returned a dismal -.38%.
Once again, we see that somewhere around the year 2000 was a turning point in
market regimes. Prior to that point, there was some evidence of strength
yielding further strength. Since then, strength has led to below average
returns. There is little of encouragement to bulls in the recent pattern.
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.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance.