Wednesday, March 08, 2006

Two Days of Strong Downside Momentum: What Next?

The past two sessions, we have had broad downside momentum in the stock market, as measured by the Demand/Supply Index monitored on the Trading Psychology Weblog. I went back to March, 2003 (N = 754) and looked for similar periods in which the two-day Supply exceeded 270 (N = 15). Two days later, the market (SPY) was up by an average of .18 (10 up, 5 down), modestly stronger than the average two-day gain of .12% for the sample overall. One week (five days) later, however, the market was up by an average of only .02% (7 up, 8 down)--much weaker than the average five-day gain of .30% over the entire period (442 up, 312 down) overall. A bounce following strong downside momentum followed by subnormal performance thus seems to be the norm.

The recent market has been hostage to bond/interest rate movements, however, so these may well be calling the shots in the near term. I'm also noticing a lead-lag relationship between the DAX and the S&P, with strength in the former leading large cap strength yesterday and weakness leading overnight weakness in the ES.