Tuesday, April 18, 2006

A (Partial) Vote of Dr. Brett's Committee

Quick update since my posting: a look at up:down volume in NYSE is bullish for the next day; check out the most recent Weblog posting.

The firmness noted in yesterday's Weblog really carried over to today's trade, fueled by the prospect that the Fed is done tightening. Meanwhile, let's look at what happens after similar strong days in the S&P 500. What I'm going to do is present several analyses, much as I do prior to each trading session. Each analysis is considered an "expert" on historical patterns and gets one vote. My leaning for the coming day's trade is determined by the net vote of my "committee of experts". This post will present only a few committee members. I generally consult a committee of at least a dozen participants.

Committee member one consists of price alone. Since March, 2003 (N = 786), we've had 49 days in which SPY has risen by more than 1.2% in a single day. There is no edge one way or another for the next day of trading, but the average three-day gain of .34% (33 up, 16 down) is much stronger than the three-day average gain of .18% (459 up, 327 down) for the sample overall. So Committee member #1 is bullish three-days out.

Committee member two consists of price and time. Basically I want to see if the recent occurrences fall into a different pattern than the older ones. When we've recently had a day that has been up by 1.2% or more in SPY (N = 24), the next two days in SPY have averaged a loss of -.01% (13 up, 11 down). When we've had a strong up day prior to December, 2003 (N = 25), the average two-day change in SPY has been a gain of .43% (18 up, 7 down). What that tells us is that upside momentum following an up day occurred early during the current bull market, but has not occurred since. Two-day returns since 2004 have been subnormal after a strong day. Committee member #2 is bearish two-days out.

Committee member three consists of price and the NYSE TRIN. When the TRIN on a strong SPY day has been very low (meaning that much volume was concentrated in rising stocks; N = 24), the three-day change in SPY thereafter has been .16% (15 up, 9 down). When the TRIN has been high on a strong day (N = 25), the three-day change in SPY has been .52% (18 up, 7 down). Tuesday was a very low TRIN day, so count Committee member #3 bearish three days out.

Committee member four consists of price and the number of stocks advancing on the day. When we've had a high number of advancers (N = 24), the next day change in SPY has been .20% (17 up, 7 down). When advancers have been relatively low (N = 25), the next day change in SPY has been -.11% (14 up, 11 down). Tuesday was a strong day for advancers, so Committee member #4 is bullish one day out; no edge three days out.

Committee member five consists of price and the price change from the prior five trading sessions. When the strong SPY day has occurred after five days of strength (N = 24), the next three-day change has been .18% (16 up, 8 down). When the strong SPY day has occurred after five days of weakness (N = 25), the next three-day change has been .50% (17 up, 8 down). Tuesday occurred after a weak five days; committee member #4 is bullish three days out.

The next Committee members consist of price, time, and those other variables. Because the most recent occurrences differ from the older ones, I see if there is any pattern in the most recent results. These members are tricky to interpret because their N is smaller and more susceptible to influence by one or two outliers. Suffice it to say that there are no distinct edges, other than a bearish pattern one day out when the strong S&P day follows five days of weakness (as on Tuesday).

So what do we have? The Committee is pretty much deadlocked. I am not going into Wednesday's trade with a strong opinion, and I am not likely to commit a large portion of my capital to any intraday setup if I'm not exploiting a longer-term, historical edge. Getting a deadlocked result and trading the next day with an open mind and smaller size is not sexy, but it's an essential aspect of money management. When the Committee is close to unanimous, that's the time to be aggressive.

Traders who survive worry about the return of their capital as well as the return on their capital.