Monday, September 29, 2008

What The Recent Gap Action Is Suggesting About The Intermediate-Term

When the market consistently gaps by significant amounts overnight it suggests skittish and news-dependent behavior. During good times, the market is not highly news-driven. People are more comfortable holding overnight or over the weekend and are not as reactive. It’s during downtrends and near bottoms that market reactions to company and economic news and reports become more volatile. I decided to run some tests using the average absolute gap.

By measuring the absolute gap I did not factor direction into the equation. A large gap up is just as “reactive” as a large gap down. The 10-day average absolute gap is currently about 3 times as large as the 100-day average absolute gap. It peaked at nearly 3.5 times on the 19th. The only other time since the inception of the SPY that this ratio has been this high is after 9/11/2001. The study below looks at 20-day performance after different multiples have been achieved.

These results are suggestive of an intermediate-term upside edge.

No comments: