Saturday, December 17, 2005

Reversal Days

Friday was interesting in that we traded about 1% above the open in SPY before reversing, going negative, and closing near the day's lows. I went back to January, 2003 (N = 744) and found 104 trading days where we closed in the bottom quarter of the day's range. Three days later in SPY, the market averaged a gain of .47% (73 up, 31 down), much better than the .14% for the sample overall (435 up, 309 down). It appears that days that close near their lows tend to reverse to show strength over the next three days. I found that smaller range days tended to reverse sooner than larger range days (such as Friday), which often saw weakness spilling into the next day's trade. By three days out, however, the size of the range on the weak day had no impact: results were uniformly bullish.

Here's the interesting thing, however. I performed a median split on the weak days based on how high above the day's open they traded. Friday, for instance, traded very solidly above its opening price before reversing. Other days start weak out of the gate and close near their day's lows. The days that traded higher above their opens were stronger three days out than days that did not trade significantly above their opens. Specifically, when we traded strongly above the open (N = 52), SPY three days out was up 41 times, down 11 (!) for an average gain of .72%. When we did not trade strongly above the open (N = 52), SPY over the next three days averaged a gain of .22% (32 up, 20 down).

In sum, days that close near their lows have been bullish three days out and days that trade well above their opens before closing near their lows have been especially bullish three days out. This will provide an interesting context to early trading this coming week.