Thursday, December 22, 2005

What Happens After a Strong Inside Day?

What I like to do with modeling is look for what is distinctive or unusual about the day's trading and then see what tends to happen subsequently. On Thursday we traded higher, following the pattern noted on Wednesday. Even though SPY was up over half a percent, however, it was still an inside day. That led me to wonder what happens after inside days and especially after strong ones.

Since January, 2003 (N = 748), we've had 99 inside days in SPY. The average three-day change in SPY for the sample overall is .14% (436 up, 312 down). After an inside day, the average three-day gain is only .02% (53 up, 46 down).

When the inside day is up by half a percent or more, however (N = 21), the average three-day change is .32% (13 up, 8 down). The remaining inside days average a three-day loss of -.06% (40 up, 38 down).

I sliced and diced the data other ways, but the modest conclusion is that outcomes are more bullish following strong inside days than weak ones. There is certainly nothing in the data to support fading a strong inside day.


Lynn H said...

What do you mean by "fading" any kind of day? Also, in your statistical look back analysis for similar patterns how have you choosen how far you look back and lastly are you currently just looking for similar occurances and their percentages or are you also looking at the "stationarity" going backwards. Thanks Lynn

Brett Steenbarger, Ph.D. said...

Fading refers to a countertrend strategy; you would fade strength by selling into it and vice versa.

I have chosen the 2003 - current period both because the data are recent and because of stationarity considerations. My modeling has been more successful relying on recent data than upon more distant data that still meet stationarity criteria.

Dave said...

Great blog Brett! I agree with your analysis of the importance of trading vehicles. I switched from NDX to Russ 2000 in early 05 for the reasons you outline here. Earnings potential is (I beleive) directly related to volatility of trading vehicle (assuming the trading vehicle is somewhat predictable).

Brett Steenbarger, Ph.D. said...

Yes, the volatility of the trading vehicle is important, but you are also right in pointing out how important it is that the trading vehicle be predictable. That is a function of having accurate and complete real time information available to you. Many markets are not centralized and thus it is impossible to obtain accurate, real-time readings of volume at each price. (Currencies are the best example of this). I personally don't know how one would profitably trade any vehicle intraday without that information, regardless of its volatility. But that's my bias... :-)

Thanks for your note.