Why last week’s price action is bullish
Science, properly executed, is a blending of the
creative and the rigorous. The scientist often relies on metaphor to craft
theories that explain observations. These creative explanations are then put to
the test through rigorous experimentation. B.F. Skinner, for example, drew upon
an evolutionary metaphor to explain how some behaviors survive and increase in
frequency and others are extinguished. His tests of this notion on animal
populations led to what we now know as behavior modification.
Creative thinking in the market can become the
stimulus for market hypotheses that we can test to identify historical edges in
the marketplace. Let’s take a recent example. Charles Kirk of
The Kirk Report referred to Friday
as a salmon day. By that he meant that the market struggled to move higher early
in the day only to be pushed backward as the day wore on. I thought that was a
particularly descriptive metaphor for what Friday’s market felt like.
Of course, that had me thinking about ways of quantifying salmon days. I decided
that, for this first attempt, a salmon day would be a day that had the following
characteristics: 1) a higher open (to show the salmon moving upstream); 2) a
move from today’s open to high that was weaker than the move from yesterday’s
close to today’s open (to show the poor fish struggling); 3) a range between
today’s high and low that exceeded 1% (to show a reasonably strong current to
the stream); and 4) today’s close within .25% of today’s low (to show the salmon
losing the struggle).
Lo and behold, I found that, not only was Friday a salmon day, but Thursday
qualified as well! Clearly this is a bagel and cream cheese market.
To my surprise, we’ve only had two other bagel and cream cheese occasions (i.e.,
two back to back salmon days) in the market since January, 1996. FWIW, the
market was solidly higher after two days following both of those occasions.
Overall since January, 1996 (N = 2625 trading days), we’ve had 90 salmon days.
Three days later in the S&P 500 Index (SPY), the market has been up by an
average .37% (54 up, 36 down). That is considerably stronger than the average
three-day gain of .10% (1420 up, 1205 down) for the entire sample. These
superior gains following salmon days occurred between 2004 and the present (N =
19), although to a more moderate degree. All three salmon days in 2006 to this
point have been solidly profitable three days later.
In short, lox aren’t so bad for stocks: traders don’t seem to get smoked after
salmon days. Indeed, after falling back following an opening advance, the salmon
tends to make some progress in the near term.
The larger point is that thinking in images and metaphors–a trademark, by the
way, of Victor Niederhoffer and
Laurel Kenner’s website–can often lead to fruitful hypotheses that can be
quantified. It is at this junction of art and science that traders can often
find creative edges in the marketplace. There are very few patterns in the
market that can’t be quantified and tested. The above analysis was performed
with nothing more than daily open, high, low, close data and sorting routines in
Excel.
Have the open mind of an artist and the hard-nosed skepticism of a scientist:
not a bad formula for market success.
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. His book, Enhancing Trader Performance,
is due for publication this fall (Wiley).