Saturday, March 25, 2006

Countertrend Equivalence - An Intermediate-Term Look

My recent Trading Markets article, along with recent blog entries here, found evidence of countertrend equivalence on a 5 day basis and, to a more modest degree, over a 5 hour timeframe. Recall that the idea of countertrend equivalence is that, if the market establishes a strong trend over X period, the next X period will tend to reverse this trend.

I decided to extend the analysis by looking at 5 week periods in SPY. Since March, 2003 (N = 155) we have had 27 strong uptrending periods on my trend measure. Five weeks later, SPY averaged a gain of .67% (16 up, 11 down), weaker than the average five-week gain of 1.36% (103 up, 52 down).

To create a relative match, I looked at the 25 strongest downtrending periods in SPY during that same time. Five weeks later, SPY averaged a gain of 2.36% (18 up, 7 down)--much stronger than normal.

Once again, we see evidence of countertrending, with moves over one period reversed in the next. The effect is especially strong for reversals of downtrends on a five day and five week basis, suggesting that these timeframes might be worth coordinating for intermediate-term trades.