Wednesday, May 17, 2006

What to Expect After a Big Drop on a Big Relative Range

Today's market, as measured by SPY, dropped about 1.9% on a range that was over 2.3 times its average daily range from the past twenty sessions.

Since March, 1996 (N = 2553 trading days), when SPY has dropped 1.5% or more in a single day with a daily range of twice or more its 20-day average, the next day in SPY has averaged a gain of .55% (30 up, 19 down). When SPY has dropped 1.5% or more in a day with a range of less than twice its average, the next day in SPY has averaged a gain of .15% (99 up, 81 down). It thus appears that a single day drop on a large range tends to bounce the following day.

Finally, combining this analysis with my last one, I found 24 occasions in which we had a one-day drop of over 1.5%, a five-day decline of over 3%, *and* a one-day relative range greater than twice its twenty-day average. Two days later, SPY was up by an average 1.02% (17 up, 7 down)--much stronger than the average two-day gain of .07% (1360 up, 1193 down) for the sample overall.

In all, it appears that we tend to get a bounce following a large decline during a weak week when the daily range is extended.

I will post details of the market drop later tonight in the Trading Psychology Weblog.


Dr. Duru said...

If you "normalized" for the pervailing trend, I bet the pattern becomes even clearer. That is, when the overall trend is up, the propensity for the bounce following the fall is even higher?

Brett Steenbarger, Ph.D. said...

Hi Dr. Duru,

I suspect you're right, and that would make for an interesting study by using a trend filter for the data. I found it impressive that the pattern of large drop on large relative range seemed to produce a large edge across the bull, bear, and low volatility conditions from 1996-2006.