Today’s candle and volume demonstrate a textbook reversal day. Candlestick analysis calls today’s candle a Bullish Hammer. Modeling today’s action shows that this setup is more bearish than market lore would have you believe.
Today’s action (Bullish Hammer) is what market technicians like to call a reversal. This happens when the market drops and makes new lows but then reverses to close higher than the open. A surge in volume is almost always present. In market lore, these reversal days are seen as being bullish both in the short and intermediate terms. A reversal day is often believed to signal that a change in trend is occurring (from down to up, in this case). This is not to be confused with a key reversal day.
The chart below clearly shows the bullish hammer as well as the volume surge:
What we want to know is if this pattern is truly bullish for SPY. Let’s test it and find out.
The Rules:
Buy SPY if
- The day’s low makes a new 100 day low
- The day’s range ((high-low)/open) is > 2%
- Volume is >1.75x the 50 day average volume
- The open is lower than the close
- ((Open – low)/open)) is > 1.5% (this is an additional variable I label the Bullish Hammer)
Sell X days later. No commissions or slippage included. All SPY history used.
The Results:
I’ve got a fair amount to cover about the results, so bear with me. Let’s start with the blue line, which shows the results of using variables 1-4 but not 5.
- There are 23 occurrences of this setup.
- Selling the close of the 3rd day after entry has the highest win rate at 55% (not great at all).
- Selling the close of the 2nd day has yielded the highest average trade at 0.99%
- After the 2nd day, the results get worse and never really improve, being bearish to neutral, at best.
Now let’s examine the red line, which shows the results of all variables 1-5. Variable 5 is what distinguishes the bullish hammer. Almost all of the setups using variables 1-5 show a fairly distinct bullish hammer. (I will include the trades below so that you can check them out).
- There are 11 occurrences of this setup.
- Selling the close of the 1st and 2nd days yields win rates of 63.94% and 70.00%, respectively.
- Selling the close of the 2nd day has also yielded the highest average trade at 2.27%
- After the 2nd day, the results turn awful to sickening to disgusting.
Bottom Line: Today’s bullish hammer candle is a bear market phenomenon. It does not typically occur during bull markets. To demonstrate this, I set the backtester to sell the trade on day 26 (note the low on day 26 the graph above). Below are the dates and results of the trades.
My opinion, which is based on these results, is that any bounce that develops over the next few days will be an excellent opportunity to open up a short position.
Those of you who have read me for some time know that I do not often advocate shorting, as the psychology is challenging and the market has a bias to the upside. However, In this case, the market does not appear to be very healthy. Indeud, SPY is trading beneath both the 50 and 200 day moving averages and a Death Cross is looming.
At the very least, position sizes should be smaller and cash should be raised. True bear markets are rare occurrences. But with economic fundamentals deteriorating quickly, the possibility of another extended bear phase should be factored into every trader’s strategy.
nice bro
$MRK = 13M, $csco = $43M , LMT = $3.5M , $bsx = 154M companies cash as of last qt; but resulted in 57% of job cuts ….what happen with $0 co. cut jobs ?
http://thehill.com/blogs/on-the-money/801-economy/175189-economy-added-114000-private-sector-jobs-in-july
Have you seen what inventories are doing? Man, it is getting nasty out there. Cutting employees is the only way to stay profitable.
thoughts on $wnr ??
I don’t follow it. Technically, it is very pretty. It just missed making the Power Dip screen on this pull back.
I love your work as of late.
Thank you Flyseph. Interesting times lead to interesting tests.
Good shit, Wood.
You excited about season 2 of the Walking Dead?
Haven’t Netflixed Season 1 yet. Is it worth a viewing? I’m more of a zombie movie guy.
My GAWD man! It is the ultimate in zombies. You have to Netflix it ASAP. Season 2 starts in Oct.
Excellent. Been waiting for some good flesh and brain eating action. Thanks for the rec.
Dayum….nothing like a good cold splash of reality to harsh the mellow of market lore. Thankee, fine sir. I could do without one of those 20+% drops – otoh, would be good to add to the drip acct
Cheese, I started yesterday buying a very small amount of GTAA in my wife’s retirement account. Will add more if we go full bear over the coming weeks.
@Wood – why that particular etf? Just being nosy – esp with so many high quality div champs yielding over 4%? I’ve got scale down orders in place for my drip acct – maybe a drop here wouldn’t be so bad…
Back to your study above – even the median score of the last 6 is grim at breakeven to slightly lower….but looking at criteria 1 – are these results less about the formation and more about the overall trend? IOW, it’s not that this formation is “good/bad” but that the context of the market is bad right now as shown by criteria 1?
Drip sandwich time….
Cheese, see my response to Beano below, re: GTAA
As for your second paragraph, for whatever reason, these setups simply do not seem to occur during healthy uptrends. So whenever they occur, we can safely assume that the context of the market is bad.
Woodshedder,
fyi, based on Mebane Faber’s timing model, (his firm sponsors the GTAA etf), by the end of August, it looks like we should be flat everything except bonds – he doesn’ t advocate shorting either.
Also, thanks for applying sound statistical analysis to market folklore; every candlestick article I’ve ever read would categorize the hammer printed on the SPY as a must take trade.
Beano, that is correct sir. I’ve been trading his model myself, and I’m tired of the extra work. I’d rather pay his 1% expense and let him manage it for me. In my wife’s account, I trade long-term trendfollowing setups.
Finally, someone who did actual leg work, and didn’t buy because a someone once told them that some pattern meant ‘buy’ back when rice was the only commodity worth caring about, but hey it wasn’t even quantified back then.
I really enjoy your work. Thanks for hitting the small folk with the big logic.
Thanks! Glad you enjoy it. The bullish hammer may well be bullish for individual securities, but the scenario presented yesterday has not been bullish for SPY.
my pleasure.
With regards to equities and hammers, it’s been my experience that what’s good for one, is not good for all. A hammer on XYZ may have a historic edge, while the same hammer in ABC is meaningless – that’s why you have to do the leg work 😉
Please, keep up the heavy lifting & the posting of those results – there are far too many dumb opinions out there and far too little enlightened ones.
The fourth rule says open is higher than close… is this a typo or did you actually test using this? Because the close was higher than the open yesterday and I also don’t think that the results would produce a hammer if you had these flipped.
Thanks,
James
Good catch james. Yes, the code used the C > O, not O > C, as I typed there. Thanks! I will edit the post in a bit.
Nice Wood. You’ve been absolutely dead on recently.
Good stuff, Woodshedder !!!
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Thanks folks. Keep the comments coming. I am out of the office today but will do my best to respond by mobile, although it hates writing in the comments section.
mrk getting killed love for you to update the numbers
On the other hand (using my trusty Excel), when one buys at the close of the first day that SPY daily close breaks the 200DMA and sells at the end of the first day when it crosses above the 200DMA yields an average $2.01/share with 100% wins.
The sample size is too small: only 7 trades since 1993
NIce Wood, wish I was in today! lol.
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