Wednesday, May 17, 2006

What To Expect After a Weak Day and a Weak Week

Today's very weak market has given us more than enough material for an enlightening historical look at edges going forward. The edges are always greatest following extreme events, and the recent market drop--especially in the context of a market that had been low in volatility--qualifies as extreme.

I will post an initial analysis here and further analyses tonight and tomorrow AM. Tonight's Trading Psychology Weblog will also contain a large amount of material on the recent market weakness and what it means for the market's near-term course.

First off, we had a drop in SPY of approximately 1.9% today, with the last five sessions giving us a decline of 4.3%. Since March, 1996 (N = 2553 trading sessions), we've had 229 days in which SPY has dropped by 1.5% or more. Two days later, SPY has been up by an average of .43% (126 up, 103 down). That is stronger than the average two-day gain of .07% (1360 up, 1193 down) for the sample overall.

When we divide the weak S&P days in half based on the performance of the past five trading sessions, we see a clear pattern. When S&P is down by 1.5% or more *and* the five-day S&P is strong, the next two days in SPY average a loss of -.06% (53 up, 61 down). When S&P is down by 1.5% *and* the five-day S&P is also weak (as at present), the next two days in SPY average a gain of .91% (73 up, 42 down).

That suggests that a very weak S&P day only has obtained a bullish edge if it occurs in the context of a weak five-day period.

Stay tuned. I will be spitting out further studies later tonight.