Tuesday, June 26, 2007

Reverse Psychology in the Stock Market: Six Consecutive Lower Lows

I notice we've made six consecutive lower lows in the S&P 500 Index (SPY). That has only occurred on five other occasions since 2004. Five days later, the market was higher four of those five occasions, with three of the gains exceeding 1% and the one loss under half a percent.

If we loosen the criteria and examine all periods in which we've had 5 out of 6 days making lower price lows (N = 61), we find a similar bullish edge five days out. Specifically, SPY averaged a gain of .59% (44 up, 17 down).

I took the pattern all the way back to 2000, identifying all occasions when five out of six days in SPY made lower price lows (N = 165). Once again, we see a bullish edge five days out, with SPY averaging a gain of .84% (100 up, 65 down). By contrast, the rest of the occasions in the sample averaged a five day loss of -.03% (891 up, 814 down).

On a related note, I see that, as of Monday's close, we were down on a five, ten, and twenty day basis in SPY. That has occurred on 170 occasions between the start of 2004 and the end of May, 2007. Twenty days later, SPY has averaged a solid gain of 1.47% (124 up, 46 down). By contrast, the remainder of the occasions in the sample averaged a 20-day gain of .53% (440 up, 245 down).

Finally, I see that we made 751 new 65-day lows on Monday across the NYSE, NASDAQ, and ASE. As noted in the most recent entry on my Trader Performance Page, this pattern has had very bullish implications going 50 days out.

We'll want to see signs of selling drying up on Tuesday, with Monday's price lows holding, to aggressively act on these bullish historical patterns.


Reversal Effects for Swing Traders

Five Day Reversal Effects in the Market

The Market Is Rigged Against Human Nature


Dr Bruce Hong said...

Excellent observation Dr Brett. Contrarian thinking at its best. This looks like it represents reversion to the mean because that gain probably does not mean a break-out Or, in other words, a return to consolidation.

D TradeIdeas said...

Dear Brett,

I hope you are feeling better. To assist in your analysis I offer the daily scans that may find such candidates down 5 days in a row.

Bruce is also quite correct. Using our Odds Maker tool extensively during our seminar at the recent Traders Expo, we find that mean reversion strategies have great winning odds and high reward to risk ratios.