Friday, October 19, 2007

Five-Day Price Relationships in the Stock Market

In a recent post, we took a look at simple 20-day price relationships and what they told us about future price changes. In this post, we'll move to a five-day basis and see if we can learn anything from similar price relationships.

As before, I went back to 1990 (N = 4482) and investigated five-day new highs and new lows in the S&P 500 cash index ($SPX).

When we have made a five-day high in the S&P 500 Index (N = 1381), the next five days in $SPX have averaged a gain of .04% (740 up, 641 down). When we've made neither a five-day new high nor a five-day new low (N = 2081), the next five days in $SPX have averaged a gain of .14% (1166 up, 915 down). When we've made a five-day low in $SPX (N = 1020), the next five days have averaged a gain of .48% (611 up, 409 down).

Once again, as with the 20-day data, we see subnormal returns following five-day highs and above average returns following five-day lows.

Interestingly, when the S&P 500 Index makes a five-day high *and* it closes above its 50-day moving average (N = 1145), the next five days in $SPX average a gain of .02% (610 up, 535 down). When the S&P 500 Index makes a five-day high and closes below its 50-day average (N = 236), the next five days in $SPX average a gain of .12% (130 up, 106 down).

It thus appears that returns are lowest when we make a five-day closing high in a market that is already extended to the upside.

When the S&P 500 Index makes a five-day low *and* it closes above its 50-day moving average (N = 466), the next five days in $SPX average a gain of .37% (284 up, 182 down). When the S&P 500 Index makes a five-day low and closes below its 50-day moving average (N = 554), the next five days in $SPX average a gain of .58% (327 up, 227 down).

As with the 20-day data, we see superior returns whenever a five-day low is made, with the best returns coming following five-day lows in markets that have been extended to the downside--a clear reversal effect.

These five-day findings largely confirm observations made by Larry Connors and Connor Sen in their book "How Markets Really Work". The test of any market indicator that is not purely price-based is whether or not it adds value to an analysis of price relationships alone. That will be the topic of follow-up posts on this theme.

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