I Don’t Know Anything Right Now

I could post some studies showing that the market tends to bounce after 5 consecutive down days, or I could post some breadth studies that show we are due to bounce. There are probably many other studies that would suggest conditions are ripe for a bounce.

Buy why bother?

The market is pile of tender and kindling right now. A spark will create a mighty conflagration.

The thing is, will this spark be further deterioration in Europe? Or will it be the announcement of an actual plan to deal with the EuroZone crisis? In other words, will it create a meltdown or a melt-up?

Ignoring the crisis overseas, markets can bounce simply due to sentiment. With the high number of bears right now, we could see a bounce, just because. And then there is the Turkey Day seasonality.

I don’t wish to be a hero right now, nor a prophet. Perhaps the only bets worth making are on volatility, and that is not my expertise. Other than that, I’m content to sit and watch. The stakes right now are too high for me to play.

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We are all Europeans, now. Well played, Merkel. Well played.

Turns out the global currency and one-world government conspiracy theorists were right after all. Kind of makes you feel stupid, no?

Since Bernanke is now going to bail out Europe, we should all look forward to financing a lavish European lifestyle. Enjoy bankrolling Greek public employee unions and 8 weeks of vacations for the French. Wait until California and Illinois find out. They will be so relieved…

After all the rugged individualism and pulling ourselves up by our bootstraps, after all that Constitution and Declaration stuff, it is fitting that the end result is that it all meant nothing. We would have been better off living by the European socialist model. Then maybe we’d all be getting bailed out by the Chinese.

Even better, perhaps the Chinese will join us in the bailout, kicking in a few trillion yuan, just for the hell of it. Bernanke, Merkel, and some Chinese finance fucker can rule in a royal triumvirate. It will be a grand nightmare, like watching a sickening porno where the menage a trois never ends. Hopefully Obama can be promoted to be community organizer, for the world.

Fuck it. I think I’m going to pack up the family and move to Germany.

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Thursday’s post examined what happened after SPY was down two days in a row, losing more than 1.5% each day. History showed that the third day saw SPY bounce more than 70% of the time. Instead of bouncing, SPY closed down on the third day. What can we expect going forward?

On Friday, SPY closed down slightly, losing roughly 0.1%. Let’s look at what happen when the bounce fails to materialize on the third day.

The Rules:

Buy SPY at the close if:

• 2 days ago SPY closed down more than 1.49%
• 1 day ago SPY closed down more than 1.49%
• Today, SPY closed lower than yesterday’s close.
• Sell X days at the close.
• No commissions or slippage included.
• All SPY History used.

The Results:

Despite a failed bounce on the third day, slightly more than 50% of trades bounced on the 4th day.

Be careful with the average returns as presented. One trade gained more than 14.5%, and it has skewed the returns. View the graph below to see the trade.

Trade By Trade Results:

Date/time shows the date the setup was completed and the buy was made.

Each day listed does not show a cumulative return starting from purchase. Instead it shows what happened on that particular day.

Again, we must be careful looking at the average returns in the first chart because we see in the graph above a 14.52% return, which is an outlier. If we remove that particular trade, the next day return drops to an average of 0.36%.

Without the outlier trade, results are not impressive. With the percentage of winning trades barely above 50%, I’m not putting much faith in a large bounce on Monday. Still, the conditions are such that we could see a large bounce.

Perhaps the major highlight of the trade by trade results is the volatility. Look how many days have returns of greater than 1%!

It looks as if the volatility beatings will continue until moral improves.

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Bespoke had an interesting post this afternoon, Down 1.5% Two Days in a Row. They show what happened the next day. I wanted to see what happened looking farther out. See below for the answer.

This is a simple test. SPY closes down 2 days in a row, and both days lose 1.5% or more. What happens the next day?

I first tried to replicate Bespoke’s results. My results were very close. They had 31 trades (counting today) and my results had 30. This discrepancy may be due to the time frame they are using. They state, “Today marks the 31st time in the last ten years that the S&P 500 has been down 1.5% or more for two days in a row.” Therefore, I tested from 11.17.2001 to 11.17.2011. Bespoke may have used a slightly different period of time.

Being reasonably confident that we were both looking at the same data, I simply looked at what happened every day following the setup, for the next 20 days, and then averaged the results.

All buys and sells are assumed to have taken place at the close, with the buy made the same close as the day the setup is realized.

The Results:

The blue line is a close approximation of the test Bespoke published.

The red line uses the same time frame as the blue but requires SPY to have closed beneath the 200 day simple moving average. This requirement eliminated only 2 trades. Hence, this setup is characteristic of a bear market.

The green line is using all SPY data, which starts in 1993.

This is bullish over the short-term, but what happens if we use the same setup and look further out?

Looking out over 50 days, we see something that looks a lot like what we’ve been seeing over the past several months: a bear market trading environment.

Let’s see if we get the bounce tomorrow. Over 70% of trades closed higher the next day after the setup occurred.

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I’ve looked at all my screens–breadth, volatility, and some others– and I’m not seeing anything here that gives me any conviction one way or the other for tomorrow. Breadth is nearing levels that typically mean a bounce is close, but we are not there yet.

My gut says that we get some follow-through on the downside. I’ve got a support/resistance line drawn on SPY at $122.21. This line has served me well over the last 1.5 years. I’m looking for that area to provide some support. Should that area not hold, SPY will find itself near to re-entering the previous consolidation zone established from August to October.  The next area of support is the 50 day simple moving average which is currently at $120.64 and just at the top of the previous consolidation zone.

I believe we are in a wait-and-see consolidation period. We are waiting to see what will happen in Europe. My opinion is simple: We are likely to continue trading between the 200MA and the 50MA until something definitive happens in the EuroZone.

I am still proceeding as if we are in a bear market. Therefore I expect that the volatility will continue and I’m guessing that the next big move will be due to news about the crisis in Europe.

Sorry for the lack of conviction. Sometimes it is best to know when you don’t have an edge and just sit on your hands until a clear signal is given.

 

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Be sure to read part one for background information.

The last post looked at recent performance using RSI2 signals to trade the SPY. What I want to do is to compare recent performance against past performance to see if RSI2 is losing its edge.

The charts below demonstrate how effective various RSI2 threshold have been at timing SPY over the time period from 1.1.2000 to 1.1.2010.

Using Low RSI2 Thresholds to Trade SPY

The above graph shows very positive average performance over the next 10 days. All thresholds finish in positive territory, and only one dips into the negative, but only for a day or so. The upward bias is obvious.

Also note how well RSI2 < 2 performed, gaining better than 1% on average after 5 days.

Now lets look at what happened if we bought SPY following a high RSI2 reading…

Using High RSI2 Thresholds to Trade SPY

The above graph shows a clear downward trend. Similar to the low RSI2 results, an extremely high, i.e., 98 or greater RSI2 reading generated a significant downward bias over the period tested.

What the above results reflect is the tendency of the market from 1.1.2000 to 1.1.2010 to revert to a short-term mean when RSI2 was either low or high. In fact, extremely low or high RSI2 readings resulted in stronger mean-reversion over the next 5 -8 days.

Now Let’s Re-visit Recent RSI2 Performance on SPY…

I have re-posted graphs from the part one showing recent (1.1.2010 to 11.11.2011) RSI2 performance so that we can compare them to the longer term graphs posted above.

Using Low RSI2 Thresholds to Trade SPY

In contrast to the longer-term tests, recent average performance has a tendency to degrade into negative returns. True, some of the thresholds have generated returns greater then 1% from 3 to 7 days after the signal, yet all but one finish negative after 10 days. I suspect the higher average returns are due to the high volatility of the last 2 years.

Note that the most extreme readings of < 2 performed the worst over the next 7 days. This is exactly opposite of the longer-term tests.

Using High RSI2 Thresholds to Trade SPY

In contrast to the longer-term tests, the last 2 years have found that high RSI2 reading have led to consolidation, small gains and small losses. We see that the most extreme readings, those over 98, have led to small gains after 10 days. Again, visually compare the two graphs and it is easy to see how high RSI2 readings have not led to pullbacks the same was as they did from the period of 2000 – 2010.

What Does It All Mean?

The RSI2 edge appears to have eroded or be eroding. However, this does not mean that an extreme RSI2 reading is no longer useful. To the contrary, an extreme reading may now be signaling a continuation of the short-term trend, rather than signaling a reversion to the mean. As I mentioned in the previous post, decades ago, RSI2 did not work well as a mean-reversion indicator.

The other point I wish to raise is that the market may be trending more in the short-term, before mean-reverting. Perhaps different RSI settings will catch this, for example, RSI3. Or, perhaps we need to be looking for short-term trend strength indicators. Having traded mean reversion setups for quite some time, I would love to hear about your favorite trend-strength indicator. I am not well-versed in that regard.

All thoughts and comments are appreciated.

 

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This series will compare the last 2 years of RSI2 performance trading SPY against the previous 10 years to see if the indicator is losing its edge.

RSI2 is a wildly popular indicator. As with any indicator, if everyone is using it, the edge may be eroded or erased. I’m curious to see whether or not we can determine if the RSI2 edge is eroding, changing, or about the same. This post will look at recent performance – from 1.1.2010 to 11.11.2011.

Most traders understand that a low RSI2 reading is a good indicator for a bounce. However, decades ago, a high RSI2 was a good indicator for continued gains, and a low RSI2 was not very successful in predicting a bounce. Instead of predicting mean reversion, decades ago, RSI2 was better as an indicator of trend strength. I have often wondered whether we will see RSI2 slowly shift back to being an indicator of trend strength rather than mean reversion.

Using SPY, I have tested various levels of RSI2, where buys take place once RSI2 crosses below or above a threshold. We want to look at what happens with both low and high RSI2 thresholds.

The tests did not include any commissions or slippage. All buys and sells were made at the close of the same day that RSI2 crossed the threshold.

Results After Buying When RSI2 is Beneath a Low Threshold

 

Results After Buying When RSI2 is Above a High Threshold

The graphs show that RSI2, when using it with a low threshold, is still a decent short-term indicator of coming mean-reversion. However, after the bounce, performance falls off rather significantly.

The high threshold tests suggest that a high RSI2 reading has tended to lead to more gains or consolidation, and does not work nearly as well to signal mean-reversion as low thresholds do.

The next post will show the same tests applied from 1.1.2000 to 1.1.2010. Then we can draw some conclusions about whether or not RSI2 is losing its edge, or if it is changing in some way.

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