I have written many posts about abnormal markets. On Friday, $SPY met a basic criteria for being abnormal with a bias to the upside.
There are times to short and there are times sit on our hands. How do we determine when to short and when to sit? One method I like is to use the upper Bollinger Band (50,2) as an abnormal market filter. I have found through backtesting that a close above the upper BB signals a market that may be entering or continuing a sustained uptrend. In other words, it is a market that is less-likely to revert to the mean and more likely to trend. This may be counter-intuitive as we typically view a market that has been sharply rising as one that is due for a correction, or at the very least, a pullback. What I have found after a close above the upper Bollinger Band is that instead of a sharp pullback or correction, we see some consolidation and then a resume of the uptrend.
Let me demonstrate.
The Rules:
Buy $SPY at the close if the close yesterday was NOT above the upper Bollinger Band AND the close today IS above the upper Bollinger Band (50,2).
Sell at the close X days later.
The Results:
These results compare buying $SPY according to the rules above vs. buy and hold. To generate the buy and hold results and have them comparable, I split all of the $SPY history into 50 day segments and then averaged the segments.
The buy and hold results show the clear bias to the upside that has been prevalent over the past 20 years. The setup results show a market that has closed more than 2 standard deviations above the 50 day mean and still manages another surge almost 2 months later to close higher on average than buying and holding.
And that is why this triggers the abnormal market filter. It is not a market that we want to aggressively short. We may also not want to be aggressively long. The results show we may have a few weeks to consider our positioning and bias.
The bottom line is that I am looking for the market to trend more than swing. Since the June 4th low, we’ve seen fairly predictable swings. These results suggest that the swings may be less predictable and the market may shrug off bad news as it climbs the wall of worry.
Thanks Wood this is good information. A small consolidation and resumption of the uptrend almost defies what others seem to be thinking. Watching the stream, many are looking for that pullback or turning bearish saying we’ve come too far too fast (and the move was fast).
Seems it would be frustrating to the masses if we didn’t get that pullback or they were scared to buy high fearing a market drop.
If fearing a drop, based on data & the huge recent buy strength it seems that the thing to do is to buy small if buying saving mental & physical capital.
Red, a small pullback here would be normal. Today’s doji makes me think it will be soon. The difference is that in the past these pullbacks have been shallow on average.
For the masses, if we consolidate and then rally, money will continue to be deployed from the sidelines and it will fuel the fire (rally).
No doubt that the economic data is concerning, but we know the market can rally despite it.
The time to get long was weeks ago but many will buy late, like always. Or not. These tests are never perfect and we could surely see a huge correction. The odds favor more trending to the upside.
This a good post with full of information so far. This post contains huge information about SPY according to the rules which is very helpful to us. Thanks and keep it up….
spy shop
Do yourself a favor, wood shedder, shortmas much DMND as you can up here. About to embark on next leg lower. It’s list out for that company as the book cooking scandal will get worseon restatement. These are the best trades out there. Chart is horrific to boot. I love hi odds plays and DMND is around a 80/20 risk play on the short side. I like those odds.
Disclosure: short a boatload from much higher prices 🙂
Thanks, I’ll take a look at it.
Wood,
My favorite play now is wait for channel breakout and fail (i.e., trap the bulls) to go short with low risk. Rationale – Weak up swings with decreasing momentum and strong resistance around 141. One challenge is channels typically persist longer than one anticipates. Hence waiting for that breakout failure. Doesn’t mean my analysis is right or always work out. Just a trader opinion on opposite side of your trade 🙂
Can’t argue with that thesis! I just play the odds and sometimes they don’t play in my favor.