iBankCoin
Joined Nov 11, 2007
1,458 Blog Posts

Bad News, Good News: A Crash, a Rally

After a large bear market breakaway gap where both the open and the close were more than -2% beneath the previous close, what can we expect in both the short and intermediate terms?

If the past is any guide to the future, things will get worse before they get better.

Today’s open gapped down -2.90% and the close finished -3.23% beneath the previous close. Truly, it was a nasty, ugly day, and the market came very close to breaking through support near $112.00. Support held, and SPY formed a doji.

Those who are very bearish after witnessing the decapitation of the bulls are right to be bearish. Those who are bullish are right to be bullish. However, the bears are likely to be right in the short term. Bulls, gird your loins. Bears, if there is a crash, take your money and run.

The Rules:

Buy SPY at the Close If:

  • The open gaps down < -2%
  • The close is < -2% beneath the previous close
  • The close is < than both the MA50 and the MA200

No commissions or slippage included. First SPY trade was 9.17.98

The Results:

Analysis of Results:

Sample size is always an issue when attempting to model a specific market event, and this study is no different. There were 19 occurrences of this setup, but only 5 samples were available if each trade were held for the full 100 days.  Therefore, these results may not be generalizable. Unfortunately, because $SPX does not record gaps, I could not use the much longer history that is available.

Look: This chart is showing the average of the trades. Actual trades were worse or better. The bottom line is that a -6% fall or +8% gain is huge and speaks to the volatility that lies ahead. Hopefully today removed all doubt, but if not, WE ARE IN A BEAR MARKET. In bear markets, one can lose lots of money. Pro tip: in a bear market, you want to sell the rips, and be very, very careful about buying the dips.

Still, the results reflect the possibility of a bottom being put in. I agree. If we can get a large flush out, I think we may have a solid bottom that can last for months.

My gut says that the near-term will look much like the chart above. I fully expect a bounce and/or consolidation, and then a gut-wrenching Armageddon-style week.

***Update***

Below is a chart showing the dates of 19 setups and the returns 1 close later.

 

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38 Reasons to a Bear

On Wednesday, 9.21.11, SPY had spent 38 trading days beneath the 50 day moving average. What does this portend for the future?

The Rules:

Buy SPY or $SPX at the close, if:

  • They have traded for 35 days beneath the 50 day moving average
  • Sell X days later
  • No commission or slippage included
  • First SPY trade 5.26.1994
  • First $SPX trade 11.1.1960

The Results

We are seeing the same phenomenon here that I wrote about yesterday. Over the last 50 years, this setup has produced a mildly bullish move for the next 60 days, but over the full 100 days, the performance is almost neutral.

Over the last 15 years (represented by SPY), results have been moderately bearish. Note the volatility in the blue line. I have been writing about how volatile this market will, and there are still no signs of it ending.

I’m guessing that the longer the market spends beneath the 50 day average, the worse future results are. I will look at that issue and the same setup beneath the 200 day average, this evening.

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A Tale of Two Bear Markets: Now vs. Then

On Friday, 9.16.11, the SPY 200 Day Moving Average (MA200) was lower than it was 35 days ago. Clearly, the MA200 has rolled over. What does it mean to have this key marker of up and down trends headed south?

I guess there is still room for debate about whether or not we are in a bear market. What exactly constitutes a bear market? Do we go out of the box and use a measure such as volatility to define it? Or do we use more typical measures such as moving averages, or percentage drops from highs?

April 29th marked the recent top of the market for the S&P 500. Sell in May and go away…From the top in April to today, 9.20.11, $SPX is down -11.8%. From the top in April to the low in August, $SPX dropped -17.9%. Neither measure reaches the standard -20% drop from highs that is commonly used to denote a bear market.

While volatility has exceeded the levels reached during the lows of 2010, it has not achieved the high levels witnessed during the Armageddon trading at the end of 2008. Volatility then is not quite a robust indication that we are in a bear market.

However, if we use the MA200, which is perhaps the most commonly used bull and bear trends demarcation, we find that the MA200 is rolling over, and it has rolled over farther than any time since the beginning of 2008.

Let’s then run this test: What happens when the MA200 of SPY and $SPX is lower than it was 35 days ago?

Buy Rules:

Buy SPY and/or $SPX at the close if:

  • The MA200 is lower than it was 35 days ago
  • Sell the close X days later
  • No commissions or slippage included
  • $SPX first trade was on 5.25.1962
  • SPY first trade was on 5.16.1994

The Results:

Above we have a graphic illustration of a tale of two bear markets.

  • $SPX shows that over the last 50 years, this setup has generally preceded a mild bull market.
  • SPY shows that over the last 15 years, this setup has generally preceded a moderate bear market.

Do we assume that now is more like recent history, or the average of the last 5 decades?

Obviously, the bear markets of 2000 and 2008 have weighed very heavily on the SPY results. We have to ask ourselves if the next 100 days will be more like the average of the last 5 decades or more like the average of the last 2 bear markets.

My best guess is that the immediate future will look more like the recent past. As I have been bearish for some time, this prediction should be no surprise, and it may just be my bias speaking more so than the result of any scientific observation.

As we attempt to determine whether or not we are in a bear market, according to this one measure, and measuring over the more recent past, we likely are in a bear market.

 

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Crystal Balling: Seeing the Future after 5 Consecutive Up Days and a Gap Down Open

Let’s pretend that you could see the future, and that you knew after you bought the close of the 5th consecutive up day, that the next open would see a nasty gap down…What would the future look like?

SPY, as of Friday, logged 5 consecutive higher closes. Futures, as of 9:10 p.m. Eastern time, are down -1.3%. Let’s see what happens after 5 consecutive higher closes and then a gap down at the open.

The Rules:

Buy SPY if:

  • SPY logged 5 consecutive higher closes
  • The next open gapped down more than -0.5%
  • Assume the buy happened at the 5th consecutive higher close
  • Sell X days later

No commissions or slippage included. All SPY history used.

The Results:

Summary of Results

There were only 9 occurrences, and 8 trades of this setup, once the 50 day hold time was accounted for. I did not specify bull vs. bear market since that would have further limited the number of trades, but the graph below will show the trade dates.

Surprisingly, a large rally seems to follow the setup, once the consolidation and mean-reversion from the 5 consecutive up days wears off.

The Trades

This study is the first bullish study in quite some time.

I’m not sure what to make of it, and with so few samples, I’m not inclined to go into Full Bull mode just because the results are bullish. I would be hesitant to sell at tomorrow’s open, and I would be inclined to give the market a day or two before exiting any positions.

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Obligatory: Four Up Days in a Bear Market

Whenever we have a string of up or down days in the market, there are always questions about what happens next…Let’s take a look at what has happened in the short and intermediate terms after 4 consecutive up days during a bear market.

The Rules:

Buy SPY at the close If:

  • It has had four consecutive days of higher closes
  • The 50 day moving average is beneath the 200 day moving average
  • The close is beneath both the 50 and 200 day moving averages

No commissions or slippage included. All SPY history used.

The Results:


Summary of Results:

There were 18 occurrences of this setup and 121 of the bull market setup.

After this setup, the market tends to pull back quickly over the next couple of days, with the average pullback nearing -2%. After the pullback, the market has tended to consolidate for a couple of weeks.

As we look out more than 10 days or so, the rest of the performance is due primarily to the moving average setup, which is commonly known as a Death Cross.

As a contrast, I ran the same 4 consecutive higher closes setup except I required a Golden Cross, which is to have the 50 day moving average above the 200 day moving average and the close above both moving averages. This is represented by the red line.

The volatile blue line against the stable red line shows just how volatile bear markets are compared to bull markets.

We are still expecting a high volatility market that will trade within a range. I still see more downside than upside, especially with the falling 50 day moving average being likely to act as significant resistance.

 

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Bear Stew: 200 Day Lows, Range Trading, and 3 Up Days

Still trying to model this mess of a market. To that end, I’ve crafted a study that accounts for the recent 200 day low, the range trading, and 3 up days in a row.

Less than 30 days ago, the market made a new 200 day low, which portends a bearish future. Since then, the market has traded in a volatile range, and until recently was working through a bear flag pattern. After breaking the bear flag to the downside, the market has closed up, 3 days in a row.

So let’s model that mess.

The Rules:

  • Buy SPY at the close IF
  • SPY made a new 200 day low < 30 days ago AND
  • SPY closed lower than its 30 day closing high AND
  • SPY has logged three consecutive higher closes

No commission or slippage is included. All SPY history was used.

The Results:

So the recipe for bear stew has yielded the flavor above. Tastes bitter to me, with a hint of acrid and a touch of burnt naivete.

Clearly, nothing has changed. Volatility, range-trading, blah blah blah. This is pretty much what I’ve been saying over the past month or two.

You’ve noticed the spike at the end of the time period. I’ve posted a graph of each trade to show when the spike arrived. The results assume each trade was held for the full 100 days.

Note that there were only 10 samples, IF each trade was held for the full 100 days. There were actually 37 occurrences of this setup. The number of samples decreases as the amount of time each trade is held increases. Confusing, I know. Drop me a comment if you need a more thorough explanation.

Anyway, the bottom line is that each bear market ends with a big rally, and 2 of these trades caught a very big rally after 9o days of bear market mania. Not too inspiring for the near term. Personally speaking, 90 days is a long time to wait, especially when after 90 days, fully 6 trades were still in negative territory.

Bottom Line: We are in a bear market. Expect large, volatile swings. There is no evidence that this will be over any time soon.

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