In my recent post, we looked at intraday price patterns in the S&P 500 Index (SPY) and found a few patterns of interest, including the frequency with which markets trade out of the range defined by the previous day's high and low price but then fall back into that range by the close. We also saw that markets that close strong are more likely to trade above their previous day's highs and markets that finish weak are more likely to pierce their prior day's lows.
In this post, we will examine reversion tendencies at an intraday level. Specifically, we'll look at how often the S&P 500 Index (SPY) closes its opening gap and how often it trades back to the average price of the previous trading day.
Going back to 2004 (N = 962 trading days), we find that SPY has closed its opening gap each day on 696 of those occasions, or about 70% of the time. We can thus see why traders commonly believe that "gaps tend to be filled". Interestingly, however, the median gap size (to the upside or downside) for the days in which gaps were ultimately filled was .14%. The median gap size for days in which gaps were not filled was .31%.
Let's look at this another way: When the opening gap up or down was greater than .35% (N = 211), the gap was filled on 97 of those occasions, or less than half the time. When the opening gap up or down was less than .35% (N = 751), the gap was filled on 599 of those occasions, or about 80% of the time.
This certainly makes sense: A large opening gap will tend to occur when a news event, economic report, or overseas market development has a significant impact upon the outlooks of traders and investors. When the market opens far from its prior day's close, there is a greater likelihood that market participants are repricing stocks in a way that will persist through the day. We should thus amend the slogan "opening gaps tend to fill" to "relatively small opening gaps tend to fill". When opening gaps are modest, fundamental events are not repricing U.S. equities and thus price will tend to drift back toward the prior day's close.
Now let's look at another price benchmark: the pivot price defined by the average of the prior day's high, low, and closing price. How often does SPY trade back to this pivot, which is one measure of the previous day's average trading price?
Note that this question is not entirely independent of the issue of opening gaps. Perhaps markets with small opening gaps (those not being repriced) are more likely to be range bound and hence trade back to the prior day's average price.
When the opening gap has been greater than .35% (N = 211), we've hit the prior day's pivot (average price) on 107 of those occasions or about half the time. When the opening gap has been less than .35% (N = 751), SPY has traded back to its pivot on 550 of those occasions, or about 70% of the time. It thus appears that markets that open with small opening gaps are more likely to trade well within the prior day's range, hitting the previous day's average trading price.
This is particularly obvious when opening gaps are very small. When SPY has opened within .10% of its prior day's close (N = 269), the gap has filled on 251 of those occasions, well over 90% of the time. On those occasions, SPY has also hit its pivot level 203 times, or about 80% of the time. A very small opening gap, particularly on days where there are no major economic reports due out and no major news stories, suggests that equities have little reason to be repriced.
Overall, going back to 2004 (N = 962 trading days), SPY has traded back to its pivot level (prior day's average price) on 657 occasions, or about 2/3 of the time. For those occasions in which SPY has returned to its pivot, it had closed the prior day a median of .31% from that pivot level. For occasions in which SPY did not return to its pivot, it closed a median of .73% from the pivot. In other words, late day strength or weakness that took the market far from its average trading price for that day--most likely an intraday breakout move--does not tend to be retraced the following day.
Another way of looking at this is that, when we close more than .40% from the prior day's pivot level (N = 508), we retouch that pivot the following day on 262 occasions, or a little more than half the time. When we close less than .40% from the prior day's average price (N = 454), we return to that pivot the next day on 395 occasions--almost 90% of the time.
If you combine the prior post with this one, you can see that we've established several price benchmarks for a daily trading session. We can calculate the odds of hitting the prior day's high price, low price, and average trading price. We can also calculate the odds of filling the opening gap. That just leaves us with one remaining set of price benchmarks: the odds of hitting prices outside the prior day's range. That will be the topic of the next post in this series. Then we will look at variables that improve the odds of hitting these price benchmarks.
Do Opening Gaps Tend to Fill?
Opening Gaps in the S&P 500 Index - Part One
Opening Gaps in the S&P 500 Index - Part Two