Thursday, May 22, 2008

Sharp Selloff A Buying Opportunity?

The market has taken a beating the last two days. This has served to relieve some of the stretched conditions I noted late last week. Most notably the CBOE put/call ratio and the VIX. (Note that the VIX system I shared Thursday afternoon triggered an exit today – good for a 2.43% gain in 3 days.) So now what? Is this a buying opportunity? Two days ago the market was hitting 4 month highs. The S&P 500 today closed about 3.5% below those highs. Let’s take a look at what has happened in the past when these kinds of sharp selloffs occur near a high:

The SPY rose 6 days in a row as of Monday. All six days have been wiped out in the last two. Looking at the 51 other such occurrences where the market has gone from a 50-day closing high to a 8-day closing low in two days, the positive expectancy going forward peaked after 5 days. A couple of weeks later, expectancy was nearly back to flat.

Here we look at a percent drop rather than an 8-day low:

Again a brief bounce that quickly peters out. I then combined the two. Only 12 occurrences but results seem notable. In this case the bounce only lasted 3 days and the expectancy beyond that turned quickly negative and stayed negative.

I ran some other tests tonight as well. So far I am not seeing anything that would lead me to believe there is a strong chance that the selloff has completely run its course.


Bill aka NO DooDahs! said...

The problem with a 1960-present study is that it combines different eras of behavior, with regard to sharp pullbacks. This is clearly spotted by my 2-day RSI study, linked here.

deke said...

many 'old trader axiom' buys for today, usually try to catch morning low: all of these can be taken on their own, including TRIN close >1.49, equity p/c close >1.04, NDX daily adx>30 and 20ema touch(holy grail), NDX rsi5 below 30(sell when touches rsi5 50), midweek reversal if mon-weds goes one way thurs-fri goes the other

Rob Hanna said...

Bill -

Thanks for sharing your study. Very interesing. With regards to my 3 studies, shortening the time frame did not substantially change the results.

If you'd care to look at the 12 dates my last study looked at they were: 2/25/75, 9/5/79, 10/9/79, 2/15/80, 8/19/80, 12/2/80, 1/9/86, 7/7/86, 11/15/91, 8/8/97, 7/20/99, 1/4/00.

Deke -

Thanks for sharing. I mentioned the fact that the market was oversold based on some very short-term indicators in my Subscriber Letter last night. Most of my current studies are bearish and I'm wary stepping in front based only on very-short term indicators when I'm seeing several indications that beyond a few days the market may struggle. I wouldn't be surprised to see a short-term bounce, but I'll mostly sit it out for now. I did take profits on most of the short positions in the Letter that had built up over the last few days. I may be willing to go long if there is more selling or I begin to see stronger upside edges. I'll look at some of the things you noted in more detail. So far evidence is not compelling enough for me to put much at risk.