We know from previous tests that when a market is making new highs, it continues to make new highs. On April 2nd, SPY made a significant new high and then pulled back, with Friday’s close down -3.3% from its April 2nd high. Is this just a pullback, or the beginning of a significant market top?
Every market top is different. When modeling a top, we want to be sure not to curve-fit the model, mainly because if it is, there will be very few usable samples from the past.
One thing all market tops have in common is that the market recently made a new high. The 2nd thing they have in common is that after the new high, the market begins to move lower. These two elements are very simple ways to describe a market top.
On April 2nd, SPY closed at a new 50, 200, and 500 day high. To make sure we are not curve-fitting our model, we will use the new 50 day high. Friday, April 13th marks 8 trading days since a new high was made. For this test, we will look for occurrences when it has been fewer than 10 days since SPY made a new high. Finally, SPY has fallen -3.3% over the 8 days since making the new high. Therefore, we will look for instances when SPY’s 8 day rate-of-change is <-2.99%.
So there is the model of our current market top. Let’s see what has happened in the past after this setup.
Buy SPY at the Close If:
- A new 50 day high was made fewer than 10 days ago
- Since making a new high, the 8 day rate-of-change is <-2.99%
Sell SPY at the Close X Days Later.
No commissions or slippage included. All SPY history used.
Using the new 50 day high parameter, there were 30 trades held for the full 50 days. I have found that to be a decent sized sample for this type of test. For fun, I added the new 200 day high and new 500 day high (200DH and 500DH) to the test/graph. This lowers the number of samples but makes the model more specific to our current environment.
To put it plainly, the results show that it very bullish for SPY to have recently made a significant new high. Even a sizable pullback similar to what we have seen over the past week has not negated the bullishness. After a month or so of consolidation, SPY has tended to begin climbing again.
These results suggest we will likely see an uptick in volatility and some consolidation and range trading over the next few weeks. This makes sense for a market that has not really taken a breather in over 4 months.
As we go forward, I’ll adjust the parameters of the model and report back on any new developments.