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New 200 Day Lows Makes for an Ugly, Volatile Future

On 8.8.11, SPY made a new 200 day low. As the results will show, a market making new 200 day lows remains volatile and prone to failure for many months going forward.

I’m still struggling with the best way to model an abnormal market that is making history daily with unprecedented action. The idea is to get enough sample sizes to feel confident about the results. The SPY’s recent 200 day low may offer just what we need: decent sample size and objective criteria to help avoid curve fitting.

The Rules:

  • Buy SPY at the Close When It Makes a New 200 Day Low (on a closing basis)
  • Sell at the Close X Days Later
  • No Commissions or Slippage Included
  • All SPY History Used

The Results:

There have been 74 occurrences of new 200 day lows. As the graph shows, once a new 200 day low is made, SPY tends to want to revisit that low.

I stretched out the results over 100 trading days as I think it is important to understand the long-term effect of a new 200 day low on the market. Based on these results, a new 200 day low seems to continue to produce a volatile, somewhat range-bound market, for many months following the occurrence.

And indeud, we have been experiencing the volatility first-hand. The blue line shows that after a new 200 day low is made, the market spasms periodically, producing wild up and down swings of 2% or more.

To demonstrate the difference in volatility, I added the results of buying SPY after it makes a new 200 day high. Newton would be proud to see his first law demonstrated so simply. In fact, this illustrates how we should be thinking about a market making new 200 day lows. It is constantly being bombarded by outside forces, whether they be economic, or psychological. In contrast to the market making new 200 day highs, almost every force is stronger than the market itself, and it is constantly buffeted by the changing winds of the economy and investor fear and uncertainty.

The market making new 200 day highs is carried by its own momentum. The momentum allows the market to shrug off bad data and investor fear and uncertainty.

A few posts ago I made the remark that this market was going to eat people alive, if they were not very careful. Looking at the blue line, I’d say the market has a voracious appetite and will be hungry for some time. Discipline is the key. One must face this market without emotion, if he wants to avoid being eaten.

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More Post Crash Analysis: Examining Volume Surges

Friday’s volume surge was greater than 2.75 times the 50 day average volume. If we treat volume as an indicator, and ignore all other variables, what does a surge in volume portend for the short and intermediate terms?

First, since everyone is concerned with the next several days, let’s look at next day, two day, and three day returns. To be clear, I have calculated returns this way: Two day returns is the return on day two after the volume surge. It is NOT the return of the first AND second day after the volume surge. The same calculation is used for the three day return.

Next Day Return

Average Next Day Return = 0.17%

% of Winners = 42.31%

Second Day Returns

Average Second Day Return = -o.08%

% of Winners = 55.10%

Third Day Returns

Average Third Day Return = 0.14%

% of Winners = 54.35%

Bottom Line:

What SPY does Monday, Tuesday, and Wednesday is hard to predict. History leans towards positive returns, but the edge is not strong. With the S&P downgrade, all analysis of the past might be meaningless.

What stands out is recent performance. Looking at the last 15 or so occurrences, note how volatile the market has become after a surge in volume. I suspect that if I dug deeper we would see that many volume surges occur during bear markets or downtrends, where we would expect a great increase in volatility. Volume just doesn’t seem to surge near tops or during uptrends the way it does during a downtrend or bear market phase.

There is an edge though, but it doesn’t show up in the short-term. It is very obvious in an intermediate term analysis. The chart below was generated by assuming one bought SPY at the close when the volume surged to greater than 2.75x the 50 day average volume. No commissions or slippage were included, and all SPY history was used.

While we are living and trading during what seems to be an unprecedented time, in the past, large volume surges have led to a strong upside edge in the intermediate term.

It is important to remember that the chart above has combined all the trades to create an average. While the average is very bullish, we may find ourselves staring down a -4% to -8% move down over the next few days. I guess we should be optimistic and realize that we could also see a +5% upside move over the next few days. Since a bounce is due, I will go against my gut and lean towards the upside rather than more downside. Again, I’m using past data, absent an S&P downgrade of the credit rating of the United States of America.

Lastly, sustained bear markets are rare events. While they are few and far between, should the market be starting another bear phase, any bounce should be used to go to cash or initiate shorts.

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Everything You Ever Wanted to Know About Today’s Crash

For today, 8.4.2011, I have $SPX down -4.78% and SPY down -4.68%. Let’s take a look at other times this has happened to see what happened next.

First, let’s examine previous dates when $SPX and SPY lost as much or more than today. I’ve also included the performance for the next day, two days later, and three days later. Keep in mind that SPY is tradeable, where $SPX is not. Also, SPY represents more recent history versus the long-term history of $SPX.

Below is the same information presented in a different format. I think it helps to see what happens after the crash day. Start with each blue bar (CrashDay) and work to the right. Notice the relationship between the blue and red bars. The large -20% loss is Black Monday.

Finally, lets look at what has happened in the intermediate term, after a crash day.

The results assume one bought the close of the crash day and sold X days later, at the close. All trades are averaged to produce the graph.

Bottom Line:

  • The next day after the crash day has averaged a positive return of >1.0%
  • The second day has also averaged a positive return of >1.0%
  • The third day has averaged a negative return of -0.77% and -0.25% for SPY and $SPX, respectively.

History has shown that the next day after the crash day tends to be positive. However, there are a few examples of the next day losing almost as much (or more, on Black Monday) as the crash day. I know many folks are concerned about what will happen tomorrow.

I want to be deadly serious here. The market is in an extremely precarious and dangerous place. People are scared and may panic more tomorrow. 2008-2009 is no doubt still fresh in the minds of many traders.

The chance that a large, extended move upward will develop any time soon is very very slim. If you choose to hold here and wait for a bounce, understand that you may only get one shot at unloading longs or getting short. If you miss the opportunity, the market could easily slide another 5-10%. It may do that anyway, without a bounce. Over the next few days and weeks, expect another move down and a test of the lows. Volatility will stay very high.

If you are not disciplined and in control of your emotions, this market is going to eat you alive. You must know what you are looking for and you must know what you will do when you see it happening.


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