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.


I've already received positive feedback re: the Twitter Trader feature now on the blog. It enables me to post brief comments about the market that ordinarily wouldn't merit an entire blog post. The last five comments are displayed on the blog. To see all the prior comments for the day, check out my Twitter page.


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!