Wednesday, December 28, 2005

Inside Day After A Fall

Wednesday traded much more like a holiday session than Tuesday, remaining in a narrow range. After Tuesday's decline, Wednesday gave us an inside day. So, I decided to take a look at what happens after inside days that follow weakness vs. strength.

Since January, 2003 (N = 752), we've had 100 inside days. In general, returns following inside days are nothing to write home about. Two days later, the market (SPY) averages no change (47 up, 53 down), compared with a gain of .09% (402 up, 350 down) for the sample overall.

When the inside day follows strength (an up day; N = 50), the next two days in SPY average a loss of -.11% (23 up, 27 down). When the inside day follows weakness (a down day; N = 50), the next two days in SPY average a gain of .12% (24 up, 26 down). Interestingly, when the inside day follows a very weak session (down by more than 1%; N = 17), such as the present situation, the next two days average a gain of .40% (9 up, 8 down).

In general, inside days following strength tend to be weaker than inside days following weakness, but there are no decisive edges in the data. It's a bit like poker: knowing when you have a hand that gives you no real odds is not exciting, but--to a pro--it's information. In time you'll draw the nuts; mucking your hand when you have nothing helps you keep your winnings. Today we've drawn 4, 8 unsuited.


Lynn H said...

Both the diamonds and spyders are showing a good consolidation pattern. I've noticed that your look back statistical look seems to focus on daily price variations by enlarge. Do you ever look back for larger patterns such as the basing patterns of dia's and spy's right now?
I wonder if the axion that the inevitable breakout is generally in the direction of the trend preceeding the consolidation has any statistical validity. Thanks, Lynn

Brett Steenbarger, Ph.D. said...


It's an interesting question, and I'll do a longer-term study to investigate. Thanks--


giancarlo said...

Risk is not a static measurement; we cannot simply look at historic volatility of a market and assume that is the way it will always be.

Historical measurements can give us a guideline of how the market should behave if things remain as they are, however as Heraclitus stated about life in Greece over 2,500 years ago "Change is the only constant."

Brett Steenbarger, Ph.D. said...


Thanks; your observation is quite correct. Looking at historical patterns only makes sense if those patterns are capturing something meaningful about markets that will persist into the near-term future. If all is changing all the time, then of course no trading is possible because price changes would be truly random.

It is difficult for me to accept that there are no regularities to markets when I work with traders who make significant money year after year, watch them trade, hear them explain their trading, and see the regularities that they exploit.

Markets are like people: they constantly change in their moods, actions, and thoughts. That doesn't mean, however, that their behaviors are unpatterned.

Lynn H said...

Brett, regarding the traders you work with, in general can you tell us what the basic trading approach is for those you make money year in year out?

Trend followers

Brett Steenbarger, Ph.D. said...

Very short-term trading. Nothing held overnight; holding time seconds to a few minutes, on average. Such high frequency trading requires execution capabilities and commission structures that are not available to the average retail trader, which is one reason I focus on longer-term patterns on my Weblog ( and on this site.