Thursday, July 19, 2007

Opening Gaps to the Upside in the Stock Market

Here is a replication of an earlier study relevant to the current market:

As I write, we're headed toward the opposite of yesterday, with the prospect of a large opening gap to the upside. Going back to the start of 2004 (N = 890 trading days), we've had 74 upside opening gaps that have exceeded .40% in the S&P 500 Index (SPY). From the open to that same day's close, we don't see any edge for the strong opening gap day. When we look from the open to the *following day's close*, however, the average gain in SPY has been .14% (43 up, 31 down). That is stronger than the average open to next day close for the remainder of the sample of .04% (437 up, 379 down).

I then broke down the strong upside gap days on the basis of whether SPY had been down or up the prior day. When we've had a strong upside gap following an up day (N = 27), the average gain from the open to the following day's close has been an impressive .33% (19 up, 8 down) for SPY. When we've had a strong upside gap following a down day (N = 47), the average gain in SPY from the open to the next day's close has been only .03% (23 up, 24 down).

In sum, as in the prior study, I don't see any open-to-close edge following a strong market open. Indeed, returns even to the next day show no bullish edge when, as currently, the prior trading day had been down. There is some indication, however, that strong upside gaps following an up market may lead to superior returns in the near term--an apparent momentum effect. This is a pattern of interest to many stockpickers, but may require more than a day trade to fully exploit.


Do Opening Gaps Tend to Fill?