Sunday, July 23, 2006

When Markets are Salmon, Do Traders Get Smoked?

Charles Kirk of The Kirk Report referred to Friday as a salmon day. By that he meant that the market struggled to move higher early in the day only to be pushed backward as the day wore on. I thought that was a particularly descriptive metaphor for what Friday's market felt like.

Of course, that had me thinking about ways of quantifying salmon days. I decided that, for this first attempt, a salmon day would be a day that had the following characteristics: 1) a higher open (to show the salmon moving upstream); 2) a move from today's open to high that was weaker than the move from yesterday's close to today's open (to show the poor fish struggling); 3) a range between today's high and low that exceeded 1% (to show a reasonably strong current to the stream); and 4) today's close within .25% of today's low (to show the salmon losing the struggle).

Lo and behold, I found that, not only was Friday a salmon day, but Thursday qualified as well! Clearly this is a bagel and cream cheese market.

To my surprise, we've only had two other bagel and cream cheese occasions (i.e., two back to back salmon days) in the market since January, 1996. FWIW, the market was solidly higher after two days following both of those occasions.

Overall since January, 1996 (N = 2625 trading days), we've had 90 salmon days. Three days later in the S&P 500 Index (SPY), the market has been up by an average .37% (54 up, 36 down). That is considerably stronger than the average three-day gain of .10% (1420 up, 1205 down) for the entire sample. These superior gains following salmon days occurred between 2004 and the present (N = 19), although to a more moderate degree. All three salmon days in 2006 to this point have been solidly profitable three days later.

In short, lox aren't so bad for stocks: traders don't seem to get smoked after salmon days. Indeed, after falling back following an opening advance, the salmon tends to make some progress in the near term.

The larger point is that thinking in images and metaphors--a trademark, by the way, of Victor Niederhoffer and Laurel Kenner's website--can often lead to fruitful hypotheses that can be quantified. It is at this junction of art and science that traders can often find creative edges in the marketplace.

Pass the cream cheese.