Wednesday, July 18, 2007

When Markets Gap Down, What Happens Next?

If the markets stay true to their overnight course, we should have a weak opening. This creates a large downside gap relative to yesterday's close. I decided to go back to the start of 2004 (N = 888 trading days) and investigate what happens after the S&P 500 Index (SPY) opens lower by more than .40% (about 6+ full ES points in the current market).

We've had 45 instances of such weak opens. From the open to that same day's close, SPY averaged a loss of -.19% (19 up, 26 down). That compares to an average open-to-close change of .02% (463 up, 380 down) for the remainder of the sample. Thus there has been some tendency toward downside follow through after a weak open.

I then looked at those occasions in which the weak open was below the lowest low price of the prior three trading sessions (N = 14). On an open-to-close basis, SPY averaged a loss of -.32% (5 up, 9 down). Once again, we see no positive edge following a weak open. Indeed, there seems to be short-term follow through to the downside on a majority of occasions. Out of the 45 downside opens, 31 traded lower by at least -.30% during the subsequent day session.

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4 comments:

Toon said...

Thanks for reporting these interesting stats.

bzbtrader said...

Dr. Brett:
Gap studies have become very popular lately. Here are a few recent print articles on the topic:
June Active Trader magazine:
One Day Jumps - by David Bukey
August Active Trader magazine:
Opening Gap Trader - staff writers
July Technical Analysis of Stocks & Commodities magazine:
Laps and Gaps - Larry Connors
Premarket Prediction- V. Wang

Humble1 said...

I have a downside target of 842 from a double top breakdown on ER2 ...see what happens.

Brett Steenbarger, Ph.D. said...

Thanks for those references, BZB Trader!

Brett