Narrow Range Days: What Comes Next?

A while back, I mentioned that I use a measure called the relative range to assess the market's daily volatility. The relative range represents the current day's high-low range relative to the average high-low range for the prior 20 trading sessions. In general, when we've had large declines on expanded relative ranges, we've seen bullish market behavior going forward. On Tuesday, however, we saw a particularly narrow range day in the S&P 500 Index (SPY), with a relative range of about 64% (Tuesday's range was 64% of the prior 20-day's average range). Moreover, Tuesday's was the narrowest range in the past five trading sessions.

Going back to 2004 (N = 759 trading sessions), we've had 152 NR5 days: days in which the current range was the narrowest in the last five trading sessions. When the NR5 days also were days in which the relative range was below 70% (N = 102), the next day in SPY averaged a loss of -.11% (46 up, 56 down). Conversely, when the NR5 day was a day with a relative range of 70% or greater (N = 50), the next day in SPY averaged a gain of .17% (29 up, 21 down). Overall, for the entire sample, the one-day average price change in SPY has been .03% (415 up, 344 down). Narrow ranges with respect to the past five and twenty trading sessions have been associated with subnormal near-term returns.

In general, returns after low relative range days have not been impressive. Since 2004, we've had 187 occasions in which the relative range has been below 70%. The next day in SPY has averaged a loss of -.03% (92 up, 95 down). For the remainder of the sample, the next day in SPY has averaged a gain of .06% (323 up, 249 down). When we've had a small relative range and SPY has been down for the day (N = 65)--as was the case Tuesday--the next day in SPY has averaged a loss of -.06% (28 up, 37 down).

These numbers are not so dramatic as to suggest selling on narrow ranges, but they certainly show that there is no bullish edge to a narrow day in the S&P 500 Index. Pretty consistently, narrow days have yielded below average returns in the short run since 2004.

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