Double Bottom: More Evidence of Changing Cycles

On Monday, we found the S&P 500 Index (SPY) establish some support near its Friday low, bouncing late in the day. I decided to look at days in which the low price of the day was within .10% of the low for the previous day. These can be viewed as candidates for double bottoms in the market. But do they really behave that way?

From March, 2003 to the present (N = 842 trading days), we've had 124 candidate double bottom days such as Monday. Two days later, SPY is up by an average of .19% (74 up, 50 down). That is stronger than the average two-day gain in SPY of .11% (452 up, 390 down).

When we divide the double bottom day sample in half, however, based upon when they occurred, a distinct pattern emerges.

When the double bottom patterns happened relatively early in the bull market (N = 62; March, 2003 - December, 2004), the next three days in SPY averaged a robust gain of .33% (41 up, 21 down). When the patterns have occurred later in the bull market (N = 62; late December, 2004 to the present), the next three days in SPY have averaged a tepid gain of .05% (33 up, 29 down).

Think of it this way: trends are what happen in between periods of consolidation. The double bottom formation is capturing a short-term consolidation in the market. Such consolidations tended to be followed by short-term gains in 2003-2004, but that has not been the case since then. How markets behave in the face of consolidation is itself a worthy trend indicator, one reason I track what the market does following "neutral trend periods" in the Trading Psychology Weblog.