Scalper1 News
SPY closed lower for the fourth consecutive day on Friday. Historical data analysis shows that the probability of another day in red is below 40%. Expected return for the next trading session is +0.3%. S&P 500 and its tracker SPDR S&P 500 ETF (NYSEARCA: SPY ) finished this trading week crashing like there is no tomorrow. It was a move not seen for a while that got market participants panicking. This was also the fourth consecutive trading session when the market went down. With a bit of simplistic historical data analysis I would like to explain why this presents a favorable setup for short term traders. SPY began trading on January 29, 1993, which gives us 5,683 trading days of data. Out of all those days, SPY closed lower on 2,580 occasions. This means that over the last 22 years the probability of a down day was 45.4%. If we investigate at what happens after a down day, we will see that on 1,141 occasions, or 44.2% of time, SPY went lower again. After two consecutive days down, the probability of another close lower decreases to 42.3% (483 instances). Extending this type of analysis to more days, we get the following table: One will immediately spot that thus far SPY has never gone down 9 trading sessions in a row . There was also only one instance when it closed lower for 8 consecutive trading sessions (any guesses when that happened?). More importantly, it is clear that the probability of a down day decreases gradually with each trading session in red. The probability spikes up at the 7th day but the sample in that category is already too small for statistical inference. One caveat about the table above is that some runs will be included in the data multiple times. For example, the recent four day decline will generate one instance (Friday) in the 4 days down bucket, 2 instances (Thursday and Friday) for 3 days down and so on. To account for that, we also take a look at the setups with exact number of down days preceded by a trading session with a nonnegative return: The interpretation of the figures above is as follows: after a nonnegative day, SPY went down 46.4% of times. After exactly one day down, SPY went lower on 45.7% of occasions and so on. Despite a slightly different methodology, the drift remains the same – the probability of a down day decreases gradually as the market slump persists. So with SPY having closed lower for the fourth time in a row on Friday, this gives us a pretty nice setup where the chance of another decline in the next trading session appears to be below 40% . Obviously, the probability in isolation is not enough and we need to complement it with expected return. The next table compares average and median return after exact number of down days: The returns tell even a more persuasive story. It turns out that not only the probability of a decline decreases with each down day but at the same time the expected return rises steadily. History tells us that with the current SPY streak of 4 down days, the expected return for the next trading session is 0.30% . Not a bad profit for a single day, which would compound to over 110% return annualized. This is not to say than one should trade such a setup without taking other factors into consideration. Proper risk management and exit strategies are required. They could also be complemented with trend indicators, seasonality metrics, fundamental ratios, etc. But at the very minimum it is a good starting point. I went long SPY at the close on Friday. Disclosure: I am/we are long SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
Scalper1 News