What I’m Reading This Weekend

A Legend Passes

A Tribute to Zweig’s Many Contributions

The ‘Death Cross’ Is Actually Bullish For Gold

Relatively Sharp 2-Day Drops From 50-Day Highs

$DIA $DJIA Historical Volatility Over the Past Century

Investor Sentiment as a Contrarian Indicator

You will find some of these articles, and more, over at The Whole Street: Quants

Yesterday evening, Frank Zorrilla @ZorTrades and I shared a few tweets where we discussed the use of Bollinger Bands (50,2) to time various market constituents. The conversation turned to Gold, and since I’ve been considering establishing a position, I thought it would be a good time to run a few tests. Frank agreed.

Unfortunately, the $GLD ETF does not have a great deal of history with which to test, so I’m going to use 2 proxies: $GOX (CBOE Gold Index) and $DJPR (Dow Jones UBS Precious Metals Subindex). Clicking on that last link will take you to a chart that allows a comparison between $GLD and $DJPR. They have tracked each other fairly close over the last year.

Although there are many different ways to assess whether Gold is a buy or a sell here, Frank and I were talking about using Bollinger Bands (50,2). Setting Bollinger Bands to (50,2) is a favorite of mine, especially as an abnormal market indicator. $GLD has closed beneath its lower Bollinger Band for the last 5 closes. Today, both $GOX and $DJPR closed for the 4th consecutive day beneath their lower Bollinger Bands. This is very significant. More about that in a bit. Let’s get to testing.

The Rules:

• Buy $GOX or $DJPR at the Close when it has Closed beneath its lower Bollinger Band (50,2)
• Sell X days later
• No Commissions or Slippage Included
• $GOX history starts on 4.22.1996
• $DJPR history starts on 1.2.1991

The Results using $GOX:

• There were 128 occurrences of this setup with 21 trades held the full 100 days. (Blue line)
• There were only 10 occurrences of $GOX making 4 consecutive closes beneath its lower Bollinger Band, with 6 held the full 100 days. (Red line)

I don’t see much to get excited about. It is a rare event for the index to make 4 consecutive closes beneath its lower band. When the index closes one day beneath the lower band and then quickly reverses to close above it, results are mildly bullish. Multiple closes beneath the lower band are telling us that something abnormal is happening. A bounce will eventually occur, but the results above show that on average, the index slid for over 3 more weeks before the bounce.

Let’s take a look at the results using $DJPR:

• There were 163 occurrences of this setup with 30 trades held for the full 100 days. (Blue line)
• There were 19 occurrences of 4 consecutive closes beneath the lower Bollinger Band, with 14 trades held for the full 100 days. (Red line)

The results leave some things to be desired, like profits. Again, one close beneath the lower Bollinger Band seems to be a fairly normal occurrence, and we can see some reversion to the mean takes hold, with average gains of 3% after 50 days. However, four consecutive closes beneath the lower band is not normal, is rare, and seems to indicate that a new trend is emerging or has emerged.

Based solely on the above analysis, I’m not comfortable establishing a position in Gold. Bollinger Bands (50,2) work well to show that a strong trend is developing when $SPY closes above them. It is not difficult to understand that consecutive closes beneath the lower Bollinger Band seem to indicate that at best, Gold will languish and trade sideways over the intermediate term. At worst, this setup may signal a new downtrend is emerging.

As noted above, this is only one study. Perhaps over the weekend we can examine the impending death cross in Gold. If there are other tests you would like to see run on Gold, let me know in the comments section. I can’t promise anything, but if you come up with something interesting and I can code it, I might give it a shot.

Well it appears that last night’s post jinxed the market today. Either that or Fly’s tweet of my post caused a disturbance in the market equilibrium. Whatever the reason, today’s little blip caused quite a bit of teeth gnashing, except for those who were magically short going into the day.

Today marked the 34th day that $SPY closed above its 20 day simple moving average (MA20). Even after losing 1.3% on the day, the ETF managed to close just above the MA20. I suspect we’ll see some follow through tomorrow, which means $SPY will likely close beneath its MA20. With that in mind, let’s look at what has happened when this setup occurred in the past.

The Rules:

• Buy $SPY or $SPX at the Close when it Trades above its MA20 for more than 30 Days and then Closes beneath its MA20.
• Sell X Days Later.
• No commissions or slippage included.
• All $SPY history used. $SPX history starts in 1928.

The Results:

$SPY results are the average of 21 trades held for the full 50 days. $SPX results are the average of 103 trades with 93 held for the full 50 days. Buy-n-Hold results are generated by chopping all $SPY history into 50 day segments and then averaging the segments.

If we were to only consider the past ~20 years of $SPY results, sample size would be a limitation in this study. The addition of almost 90 years of $SPX results lends more reliability to the results.

Its hard to ignore the edge here. If $SPY closes beneath its MA20 tomorrow, the future will look bright for the next 10 to 15 trading days. After that, history guides us to expect some consolidation or another small pullback.

For the traders who woke up today and magically found themselves short, neat trick. For the bulls, if the edge prevails, all of today’s losses will likely be erased. At that point it would be wise to consider whether to continue pressing your luck without reducing exposure or adding hedges.

And by big down day, I mean a day where it loses more than 0.99%. Recently, $SPY has traded for significant amounts of time without a big down day.

• On 1.27.11, $SPY had traded for 42 days without a significant down day.
• On 3.5.2012, $SPY had traded for 45 days without a significant down day.
• On 9.24.2012, $SPY had traded for 44 days without a significant down day.

What does all this mean? I don’t really know. Sometimes it is just fun to play around with the data. I played around with idea before here: 40 Days Without a 1% Pullback: Bullish or Bearish?

Today was the 10th day $SPY has traded without a down day of <-0.99%. Let’s treat this as a setup and look at what has happened in the past.

The Rules:

• Buy $SPY at the close when it has been > 10 days without a down day of <-0.99%
• Sell at the close X days later.
• All $SPY history used.
• No commissions or slippage included.

For fun, I’m adding an additional variable (Setup & DD<-0.99%) which is simply the setup and a down day of <-0.99%.

The Results:

So yeah, nothing much to see here. The setup tracks fairly well with buy-n-hold.

Perhaps one takeaway is that once the down day occurs, results tend to get a tad more volatile. However, without running more tests, I can’t say for sure that the increased volatility is due to the down day or because the market is changing after the down day or because there were fewer samples.

It would be a mistake to assume that just because $SPY hasn’t had a big down day that performance will revert to the mean. Instead, there may be a miniscule edge here.

It is interesting that 3 of the top 5 ranked Fidelity sector funds are transportation related. Also noted is that Environment and Alternative Energy has been knocking around in the top 5 and is looking to make a break into the top 3.

1. FSAIX – Air Transportation
2. FSRFX – Transportation
3. FSLBX – Brokerage and Investment Management
4. FSLEX – Environment and Alternative Energy
5. FSAVX – Automotive Portfolio

The system I use to rank and trade these is +5% for 2013, having earned 3.4% in January and another 1.6% for the first half of February. System equity recently made a new all-time high.

Some interesting HTFs for Tuesday. While some of these are forming perfect little pullbacks, Bulkowski’s rules require buying on a breakout above the flagpole high. Still, the pullbacks are tempting setups…

I especially like $VIPS as it appears ready to breakout at any moment.

The Death of Intra-day Reversals?

Applied Academic Research: Momentum, Momentum, Momentum

Embracing What’s Working Now

Raging Bull: A Trading Strategy that Beats the Bull Market?

Scaling In Confusion

You can find all these posts, and more, over at The Whole Street: Quants.