S&P 500 Still Working Through Process of Normal Pullback

A couple of weeks ago I wrote that modeling of similar setups showed that SPY was likely working through a normal pullback and not making a significant top.

This post continues with the same line of inquiry, the goal of which is to model recent SPY behavior without making the model so specific that there are not enough samples to backtest.

SPY made a new 50 day high 18 days ago and the 18 day rate-of-change is a tad more than -1%.

All I have done is told the backtester to find other similar instances.

The Rules:

Buy SPY at the close if

  • It made a new 50 day high >15 days ago and <20 days ago
  • The 18 day ROC is <-1% and >-2%

No commissions or slippage were included. All SPY history was used.

The Results:

The results look very similar to the previous study. After a period of consolidation, the rally continues. There were 29 occurrences of this setup, and 22 of them were held for the full 50 days.

As I’ve said before, there is nothing magic here. Making new 50 day highs is a big deal, and the momentum tends to persist. Perhaps the most important takeaway is that when SPY is making new 50 day highs, it seldom goes more than a few days or a week before making another new high. If SPY goes any longer without making a new high, it is likely pulling back.

I calculated the average SPY buy-n-hold return by chopping all SPY history into 50 day segments and then averaging the segments.

The most recent example of this setup occurred when a pullback began on 11.8.2010. Another example was the pullback that began on 8.10.2010.

Study: This is Likely Only a Pullback, Not a Significant Market Top

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.

The Rules:

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.

The Results:

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.

 

Dow Repeats Great Depression Pattern? Maybe?

I was reading this CNBC article featuring this quote:

The Dow Jones Industrial Average is repeating a pattern that appeared just before markets fell during the Great Depression, Daryl Guppy, CEO at Guppytraders.com, told CNBC Monday.

“Those who don’t remember history are doomed to repeat it…there was a head and shoulders pattern that developed before the Depression in 1929, then with the recovery in 1930 we had another head and shoulders pattern that preceded a fall in the market, and in the current Dow situation we see an exact repeat of that environment,” Guppy said.

I guess, maybe, this is wisdom, if a loosely quantifiable technical pattern can define a market “environment.” To call it “an exact repeat,” we would need to see the evidence. Let’s take a look. Note that the CNBC article did not include any charts.

Click on the charts to enlarge…

Dow Jones Industrial Average 1929-1931

Dow Jones Industrial Average 2008-2010

Okay, sure, we have a head and shoulders pattern in both charts. Honestly, I see numerous H&S patterns in both charts. But to call this “an exact repeat” is quite a stretch. That doesn’t mean we won’t see a brutal market swoon, a la 1930, over the next several months. There are certainly similarities, but there are also clear differences.

The take-away from this is to be careful when dealing in absolutes (an exact repeat?) and technical chart patterns. Unless the patterns are quantified, there simply are no legitimate absolutes.

Dow Jones Charts: 1921-1945

Comparing the current top (below, circled in red) with the 1929 top (above) clearly shows just how bad things can actually get. If we are to experience a prolonged meltdown, it appears the indexes have the potential to fall a lot farther than anyone is even imagining.

Update: I added the Nasdaq Composite chart at the very top as requested in the comments section.

From the top in 1929 to the bottom, the Dow Jones lost almost 90%. Were something similar to happen today, we would be seeing the Dow Jones print 1620.

Seeing a 50% drop from the October 2007 top seems more likely. I would not be surprised to see the Dow Jones print somewhere as low as 7,000-8,000.

I included this weekly look at the Depression Top for some comparison to the current top. Again, current charts look like they still have a ways to go.

Examining Market Tops and Bottoms: A 7 Year Historical Perspective

Nasdaq 7 Year Weekly

The last 2 weeks saw the indexes challenge 5 year trendlines as established from the lows of 2002. It is interesting that the action of the last few months looks very similar to the action during the 2000-2002 Bear Market. Actually, as the Nasdaq is still well beneath its all-time highs, it has been in a Bear Market since 2000. However, it currently looks the least “toppy” of all the indexes. On the weekly chart, it looks more like a correction than the beginnings bear market.

DJI 7 Year Weekly

The Dow Jones has barely managed to stay above its 5-year trendline. However, it is staying above its all-time highs of 1999, meaning it is the only index higher now than 7 years ago, unless one adjusts for inflation.

SPY 7 Year Weekly

The SPY and the DJI have put in beautiful Head & Shoulders tops. Note the huge Bear Market rallies during 2001. We have yet to see a snapback rally of such a large magnitude. If the downtrend is maintained for some time, it would not be unlikely to see such a snapback rally.

Overall, the last 5 years is starting to look like nothing more than an extended Bear Market rally, as the DJI is the only index still above the highs of 1999-2000.

Examining Market Tops: 1990 S&P 500

SPX Correction 1990

With all the talk of financials having bottomed (what about the other 80% of the S&P?), I think it is prudent to continue examining how market tops look. There has also been many mentions that this correction is like 1990, so lets examine the S&P 500′s 1990 top.

Unfortunately volume data is not provided, which makes it impossible to spot capitulation. However, the MACD did a great job of diverging from price and gave astute technicians an entry right at the bottom. Notice the Stochastics also do a great job of identifying each turn.

In this chart, observe the 50 day average. As the price re-takes this average, the bottom is in.

Comparing this top and bottom to the current SPX chart, it seems to me the average still has a good deal of unwinding to complete before bottoming. I would also like to start seeing some bullish divergences emerge. And most importantly, price needs to retake the 50 day average. However, the SPX is entering the 4th month of its correction phase. In 1990, the bottom was found in the 4th month.

Read other posts in the Examining Market Tops series here: Examining Market Tops.

S&P 500 Still Working Through Process of Normal Pullback

A couple of weeks ago I wrote that modeling of similar setups showed that SPY was likely working through a normal pullback and not making a significant top.

This post continues with the same line of inquiry, the goal of which is to model recent SPY behavior without making the model so specific that there are not enough samples to backtest.

SPY made a new 50 day high 18 days ago and the 18 day rate-of-change is a tad more than -1%.

All I have done is told the backtester to find other similar instances.

The Rules:

Buy SPY at the close if

  • It made a new 50 day high >15 days ago and <20 days ago
  • The 18 day ROC is <-1% and >-2%

No commissions or slippage were included. All SPY history was used.

The Results:

The results look very similar to the previous study. After a period of consolidation, the rally continues. There were 29 occurrences of this setup, and 22 of them were held for the full 50 days.

As I’ve said before, there is nothing magic here. Making new 50 day highs is a big deal, and the momentum tends to persist. Perhaps the most important takeaway is that when SPY is making new 50 day highs, it seldom goes more than a few days or a week before making another new high. If SPY goes any longer without making a new high, it is likely pulling back.

I calculated the average SPY buy-n-hold return by chopping all SPY history into 50 day segments and then averaging the segments.

The most recent example of this setup occurred when a pullback began on 11.8.2010. Another example was the pullback that began on 8.10.2010.

Study: This is Likely Only a Pullback, Not a Significant Market Top

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.

The Rules:

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.

The Results:

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.

 

Dow Repeats Great Depression Pattern? Maybe?

I was reading this CNBC article featuring this quote:

The Dow Jones Industrial Average is repeating a pattern that appeared just before markets fell during the Great Depression, Daryl Guppy, CEO at Guppytraders.com, told CNBC Monday.

“Those who don’t remember history are doomed to repeat it…there was a head and shoulders pattern that developed before the Depression in 1929, then with the recovery in 1930 we had another head and shoulders pattern that preceded a fall in the market, and in the current Dow situation we see an exact repeat of that environment,” Guppy said.

I guess, maybe, this is wisdom, if a loosely quantifiable technical pattern can define a market “environment.” To call it “an exact repeat,” we would need to see the evidence. Let’s take a look. Note that the CNBC article did not include any charts.

Click on the charts to enlarge…

Dow Jones Industrial Average 1929-1931

Dow Jones Industrial Average 2008-2010

Okay, sure, we have a head and shoulders pattern in both charts. Honestly, I see numerous H&S patterns in both charts. But to call this “an exact repeat” is quite a stretch. That doesn’t mean we won’t see a brutal market swoon, a la 1930, over the next several months. There are certainly similarities, but there are also clear differences.

The take-away from this is to be careful when dealing in absolutes (an exact repeat?) and technical chart patterns. Unless the patterns are quantified, there simply are no legitimate absolutes.

Dow Jones Charts: 1921-1945

Comparing the current top (below, circled in red) with the 1929 top (above) clearly shows just how bad things can actually get. If we are to experience a prolonged meltdown, it appears the indexes have the potential to fall a lot farther than anyone is even imagining.

Update: I added the Nasdaq Composite chart at the very top as requested in the comments section.

From the top in 1929 to the bottom, the Dow Jones lost almost 90%. Were something similar to happen today, we would be seeing the Dow Jones print 1620.

Seeing a 50% drop from the October 2007 top seems more likely. I would not be surprised to see the Dow Jones print somewhere as low as 7,000-8,000.

I included this weekly look at the Depression Top for some comparison to the current top. Again, current charts look like they still have a ways to go.

Examining Market Tops and Bottoms: A 7 Year Historical Perspective

Nasdaq 7 Year Weekly

The last 2 weeks saw the indexes challenge 5 year trendlines as established from the lows of 2002. It is interesting that the action of the last few months looks very similar to the action during the 2000-2002 Bear Market. Actually, as the Nasdaq is still well beneath its all-time highs, it has been in a Bear Market since 2000. However, it currently looks the least “toppy” of all the indexes. On the weekly chart, it looks more like a correction than the beginnings bear market.

DJI 7 Year Weekly

The Dow Jones has barely managed to stay above its 5-year trendline. However, it is staying above its all-time highs of 1999, meaning it is the only index higher now than 7 years ago, unless one adjusts for inflation.

SPY 7 Year Weekly

The SPY and the DJI have put in beautiful Head & Shoulders tops. Note the huge Bear Market rallies during 2001. We have yet to see a snapback rally of such a large magnitude. If the downtrend is maintained for some time, it would not be unlikely to see such a snapback rally.

Overall, the last 5 years is starting to look like nothing more than an extended Bear Market rally, as the DJI is the only index still above the highs of 1999-2000.

Examining Market Tops: 1990 S&P 500

SPX Correction 1990

With all the talk of financials having bottomed (what about the other 80% of the S&P?), I think it is prudent to continue examining how market tops look. There has also been many mentions that this correction is like 1990, so lets examine the S&P 500′s 1990 top.

Unfortunately volume data is not provided, which makes it impossible to spot capitulation. However, the MACD did a great job of diverging from price and gave astute technicians an entry right at the bottom. Notice the Stochastics also do a great job of identifying each turn.

In this chart, observe the 50 day average. As the price re-takes this average, the bottom is in.

Comparing this top and bottom to the current SPX chart, it seems to me the average still has a good deal of unwinding to complete before bottoming. I would also like to start seeing some bullish divergences emerge. And most importantly, price needs to retake the 50 day average. However, the SPX is entering the 4th month of its correction phase. In 1990, the bottom was found in the 4th month.

Read other posts in the Examining Market Tops series here: Examining Market Tops.