Monday, May 08, 2006

Rest Day After Strength: What Comes Next?

Monday's market took a pause after Friday's vigorous rally, with some of the narrowest trade since the bull market began in 2003. What happens after we get such a rest day after market strength?

I went back to March, 2003 (N = 800) and identified all occasions in which the most recent trading day in SPY had a narrow range of .50% or less (N = 53). The next day in SPY averaged a loss of -.13% (21 up, 32 down), much weaker than the average gain of .06% (446 up, 354 down) for the sample overall.

When the narrow day followed two days in which SPY had been up more than .50% (N = 25) (such as is the case at present), the results were even more bearish. The next day in SPY averaged a loss of -.16% (9 up, 16 down), with weakness extending three days out (-.28%; 9 up, 16 down).

It thus appears that a narrow day after a market rise is not a pause that refreshes, but rather may indicate an exhaustion of the rally. Incredibly, 10 of the last 11 times this pattern has occurred (since 2/05), the market (SPY) has been down three days later.