Smooth Moves and Choppy Seas - Part Two

In my last entry, we found that 10-day rises that were smooth--i.e. that had seven or more of its days finishing to the upside--had a more favorable short-term outcome than ten-day rises that were choppy, with four or more declining days in the mix. This was not because the smooth rises were larger than the choppy ones; their average size was quite similar. Rather, it appears that how a market moves from Point A to Point B matters as much as the size of the move itself.

I went back to the entire sample from February, 1996 (N = 2618 trading days) and simply compared smooth ten-day rises in SPX (those with 7 or more up days) with smooth ten-day declines (those with 7 or more down days). Here there is an obvious overlap with price change: the smooth 10-day rises averaged a gain of 3.24%; the smooth 10-day declines averaged a loss of -4.05%.

When SPX had seven or more days out of 10 to the upside, (N = 499), the next five days in SPX averaged a gain of only .08% (288 up, 211 down). That is no better than the average five-day change of .16% (1422 up, 1196 down) for the entire sample. When SPX had seven or more days out of 10 to the downside (N = 301), the next five days averaged an above average gain of .47% (174 up, 127 down). That is quite a bit better than average.

A different pattern appears when we look 20 days out, however. When SPX has been up 7 or more times out of 10, the market 20 days later averages a gain of .82% (302 up, 197 down). That is a bit stronger than the average 20-day gain of .61% (1521 up, 1097 down) for the entire sample. When SPX has been down 7 or more times out of 10, the market 20 days later averages a gain of only .36% (156 up, 145 down).

When we put those results together, what we find is that markets that move smoothly do not follow through on their moves in the next five trading sessions--and indeed often correct a bit--but then do follow through with their original moves in the subsequent 15 sessions.

The paths of various rises and falls across different time frames strikes me as a fruitful line of further inquiry. A smooth trending move appears to correct in the short run before continuing in its original direction thereafter.