Friday, January 20, 2006

High Volume Steep Decline: What Comes Next

Friday's market moved sharply lower, with SPY down 1.82% on volume that was 136% of its 20 day average volume. What typically happens after such a decline? I will provide a preliminary analysis here, but will follow up tomorrow with further analyses.

I went all the way back to January, 1998 (N = 2022 trading days) and found only 29 days in SPY that were down more than 1.5% on volume that exceeded the 20 day average by more than 75%. Large, high volume declines have thus been rare--especially recently. During this low volatility bull market, we've only had one occurrence: 3/10/04. The market followed that down day with a further decline of 1.3% the next trading day.

Over the next three trading days, when we've had a steep decline on large volume (N = 29), the market has been up 19 times, down 10 for an average gain of .83%. That is quite a bit better than the average three-day gain of .06% (1091 up, 931 down) for the sample overall. There is thus a tendency to rebound over the near term.

Interestingly, the day after a high volume steep decline tends to be a big day, whether up or down. Of the 29 occurrences, 19 were either up or down the next day by more than a full percent, and 8 of the 29 moved more than 2%. This reflects serial volatility: highly volatile trading days tend to be followed by days that are above average in volatility. In fact, the average absolute one day change in the sample was .92%, but the absolute one day change following a high volume steep decline was 1.56%.

More to follow...