Intermediate-term Consequences Of A 30's-Like Market

I don’t normally reprint large sections of the Subscriber Letter on the blog but I’ve received several inquiries about the longer-term and I figured, “What the heck.” Below is from this week’s intermediate-term outlook:

The question that I keep hearing over and over is “Is this rally for real?” What needs to be considered when formulating an answer is what constitutes a “real” bull move. It is my contention that the current environment most resembles that of the 30’s from a trading standpoint. Certainly the kind of damage that has been done to the market has not occurred since at least that time period. Additionally, volatility levels reached during the course of this bear have reached levels not seen since at least the 30’s in some cases.

I’m of the belief that the market is likely to trade in a very wide range over the next few years. It is unlikely to begin a new secular bull market during this time. Rather I believe we are likely to see both bull and bear runs occur. Some of these, such as the October and November rallies, may be too quick for most traders to capture significant portions of. Others may last several months before reversing course in a convincing manner. Below I’ve again pulled up some charts from the 30’s. In this case I’ve overlayed the zig-zag indicator in light blue.

What the zig-zag does is identify all moves of at least 15% either up or down from close to close. You’ll notice there were a substantial number of these moves during that time:

Late 1929 – late 1934. (created with Tradestation)

Lots of sharp sizable moves can be seen during the period. The 1932 low seen here is "the" low.

Next is late ’34 to late ’40 (created with Tradestation):

Several bull and bear markets could also be identified here.

The next great bull move, though didn’t take place until 1942 as can be seen below:


So is it for real? Well, I’m not at all convinced that we’re looking at a 1942 bottom at this point. My contention is we are likely years away from that. The moves seen between 1929 and 1941 offered plenty of opportunity, though. I expect the next several years of this market will as well. Traders need not worry whether we are in a bull or bear market. Leave that to the media and instead just focus on the likely direction based on the evidence for the next few days, weeks or perhaps months. Remain nimble in your assessment as conditions may change rapidly. Whether the “ultimate” bottom gets hit is irrelevant. The ultimate bottom in the charts above was made in 1932. Close to 10 years passed before the next great bull market emerged. Picking that 1932 ultimate bottom and riding the wave higher was not the key to big profits. Much more important than picking the bottom would have been to stay nimble and take advantage of some of the vast directional opportunities over the next 10 years – prior to the “real” bull emerging.

A few quick notes pre-open

Well, I was going to post a study suggesting more downside along the lines of this one. With the futures down close to 2% that seems unnecessary. Therefore readers may rather check out the “2% Gaps Down” table from a while back.

It should be noted that since that study there have been 3 more instances – 2/17, 2/27, and 3/5. (I personally did not consider the 2/17 one valid because it came after a US holiday when the foreign markets were open for 2 days.) In every case the market continued lower that day, unlike many in the study. Also, the 3/5 instance was the only one of the 3 that managed a higher close in the next few days. I still consider a 2% gap open to have a short-term bullish influence, though. The 2/27 instance is really only the 2nd true maverick, along with 10/6/2008, among the bunch.

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Two Strong Up Days Under The 200 Revisted

For the 2nd day in a row the market finished up strongly on Thursday. Over a year ago on the blog I posted a simple study that looked at S&P performance following two consecutive days where it rose at least 0.75% and closed below the 200ma. At the time the 0.75% hurdle was a good sized 1-day move. In the last year a move of that magnitude hasn’t been significant. Still, I thought it would be interesting to go back and run the results again using the same parameters.

These results are similar to the ones I showed last year. In fact the negative influence is now even more pronounced. To see how poorly the market has performed under these conditions in the last year I re-ran the test to show just the time period since the original blog piece:

The fact that the 0.75% hurdle has become easier to achieve hasn’t weakened the bearish influence of the setup. I attribute a large part of reason for this to be the exceptionally choppy environment the market has been in over the time period.

Should The 2% Gap Study Be Adjusted For Volatility?

On Tuesday I posted a study that looked at 2% gaps in the SPY and what the response has been following such a large gap. Afterwards I received an email from a reader who posed the following question:

Rob... a thought on gaps. Perhaps they should be measured in terms of recent ATR volatility rather than an absolute amount like 2%. A 2% gap when ATR_20 is 2% would seem to mean something different than when ATR_20 is 1%.

It’s a good point, and one that has been raised before, so I thought I’d share my answer with you.

The reason I’ve stuck with the absolute number so far is twofold: 1) If you look at the times when the 2% gaps occurred they were all during relatively volatile periods. This somewhat reduces the need to filter by ATR. 2) If I use ATR as the criteria INSTEAD of an absolute 2%, then I will also get a number of gaps that are much smaller included in the study. Is a 1% gap in a non-volatile period the same as a 2% gap in a volatile period? Perhaps from a psychological standpoint it is similar, but if you’re using it to project returns going forward then I’d say it is much different.

Perhaps the best solution would be “2% AND at least an ATR of X”. With only 32 instances to start with I hate to filter too much though.

Unfortunately, I don’t think there is a right way to do it. Hence the reason I typically try and test multiple ideas and take into account not only price movement, but relative volume, breadth and sentiment as well. You get enough things saying “buy” or “sell” and you’ve got a decent chance of being right.

Is There Still A Tendency For 2% Gaps Up To Pull Back In The Next Few Days?

Below is a table that first appeared on the blog last fall. It shows how long it took for the SPY to close below the open of an extra large (2%) gap higher.

(click to enalrge)


What was once a very strong tendency now appears to have lost much of its edge as four of the last nine 2% Up Gaps have failed to post a close below the gap open within the next week. What’s interesting about the "failures" is that they all occurred either 1 or 2 days after the market had closed at a 200-day low. In fact, the only one that was 2 days after was Monday 11/24/08, which was the day after the 11/21/08 occurrence that also didn’t pull back. Monday the market was far removed from its 200 day low. Of course SPY would need quite a pullback if it were to close below Monday’s open anytime in the next few days.

Large Gaps Up Since September 2008

Last year I did some studies on the blog that looked at how the market reacted to different morning gap sizes. I defined a “large gap” as anything greater than 0.75%. Since early fall that hasn’t even been an average size gap. As I’m writing this in the morning the futures are up almost 3%. Below are the results of a test that looked to buy just after a large gap up and then sell at the end of the day. They are run for varying gap sizes going back to September 2008.



Large gaps higher in downtrends have historically shown a propensity to squeeze shorts and continue higher over the course of the trading day. This propensity has continued to exist over the last 6 months or so while the market has been especially “gappy”.

A 20% Rally In Under 2 Weeks

The current rally has seen the S&P 500 rise over 20% above its recent lows. I looked at other times back to 1960 where the S&P rose 20% or more within a 2-week period. There have only been 3 other instances: November 2008, October 2008 and Following the Crash of 1987.

While the Dow hasn’t managed a 20% gain yet I did use it to look back to 1919. There was only one other period where there was a cluster of multiple rallies of 20% or more in 10 days or under. That period was 1931-1933. Below is a chart of the period. I’ve noted every 20% 10-day rise with a buy signal. The sell signal occurs 20 days later so you can more easily see how it performed after the rise.

Short-term results were mixed. As a whole this was a horrible time for both the stock market and the economy.

When The S&P Is Overbought Going In To A Fed Day

Wednesday is an FOMC meeting. In the past I’ve produced numerous studies examining how the market has performed surrounding these meetings. One scenario I have not yet shown is how the market has performed when it is short-term overbought go into the meeting. For this test I used a 2-day RSI to measure different levels of overbought.

(click to enlarge)


Over the last 19 years when the market has had positive momentum going into a meeting it has most often been able to maintain that momentum through the day of the announcement.

When SPY Gaps Up 1% And Closes Negative

What stood out to me about Monday was the fact that the market gapped higher by such a large amount and failed to close positive on the day. Below I look at other times the SPY gapped up 1% and finished negative.



While instances are a bit low, additional downside follow through was often seen over the next 1-3 days.

Tweetdeck for Traders

Twitter has been increasing in popularity as an application for bloggers.

Dr. Steenbarger of Traderfeed produces invaluable information for traders through Twitter. He supplies followers with not only links, but proprietary indicator updates and real-time analysis and observations.

Jeff Pietsch from Market Rewind also sends out real-time market observations on Twitter.

Personally I’ve subscribed to both services via Twitter, and Dr. Steenbarger’s Twitter service through the RSS feed. The frustration I’ve experienced in following them is that even with an RSS feed the Twitter update may not arrive for an hour or so. And even then I’ll only notice it if I happen to flip over to my reader application. Trying to follow real-time commentary on a much delayed basis just doesn’t provide the same value. This is no fault of theirs as the information is good and timely.

This all changed recently. Why?

I discovered Tweetdeck. Tweetdeck is a free beta application that updates and organizes Twitter feeds that you are subscribed to. It updates once per minute and can be set to notify with a tweet sound and popup when a new tweet arrives. It makes manually refreshing Twitter or subscribing to an RSS feed obsolete. I’d strongly recommend everybody check out the free twitter services from Dr. Steenbarger and Market Rewind. And with Tweetdeck you’ll have real-time insight from some terrific intraday traders.

If Twitter updates aren’t enough you should also note Market Rewind just started a chat feature accessible from his main page.

Other worthwhile Twitter feeds to follow are Corey at Afraid to Trade and Greenfaucet – though neither are quite as dependent on real-time up to the minute information.

I’m admittedly no expert on Twitter. I’ve never sent a tweet and have no plans to offer any such service. If anyone knows of other valuable tools or services that could be incorporated with Twitter I’d encourage you to post about them in the comments section.

Subscriber Letter Trade Results For February

So I finally got around to putting together the stats for February for the Subscriber Letter and have included them below. There are very few trades that were closed out in February. There were several active ones that didn’t get closed out until March. For simplicity I’ve always just reported the closed trades. I see no point in marking to market at the end of each month and running complex stats. Reason being this is NOT a performance report. No allocation sizes are suggested and the trade ideas are not presented as a portfolio, but rather a list of actionable ideas that I track. The February results were once again excellent. March got off to a rough start with a couple of individual trades. This week has been good but there’s a decent chance it may have the first negative total since last August. I’m getting ahead of myself, though. Below are some of the usual caveats followed by the February summary results.

As mentioned above, I don’t suggest position sizes. The primary reason for this is I’m not acting as a financial advisor. I don’t feel it is appropriate to suggest allocation sizes without understanding someone’s financial situation and risk tolerance. Even for my own trading I run different portfolios with different levels of aggressiveness. For instance, my most aggressive portfolio is my IRA. Here I may use options to sometimes get 400-500% leveraged. Other portfolios on the other hand normally take much more conservative stances and some rarely reach or exceed 100% exposure.

Since I don’t suggest position sizes this is should not be considered a performance report, but rather a trade idea scorecard. Therefore, no matter how objective I try to be the reporting of the results is always going to be skewed depending on how you approach the trades. For instance, I always recommend scaling into the Catapult positions in 3 parts, whereas the “System” trades (whatever system I unveil other than Catapult) are normally one entry. The “Index” trades I normally recommend scaling into as well. For my own trading I trade much larger size with the index trades than any of the individuals. I also control my exposure by limiting the total amount invested per day. As I mentioned, this will vary depending on the account I’m trading. My most aggressive account I may put in up to 100%/day and get heavily leveraged using options. A more conservative account may max out at 15%-20% per day.

It’s unlikely anyone would have taken all of the trades with equal amounts, so personal results would vary greatly depending on the trader’s approach. Simply adding up the results of the individual triggers as I do below is an admittedly poor representation of returns. A net positive or negative does not necessarily mean a person following the ideas would have made or lost money during the period measured. And the sum total is certainly not representative of what a portfolio would return. All that aside, below are February’s results (click to enlarge):



Detailed trade by trade results will appear in this weekend’s Subscriber Letter. If you haven’t checked out the gold membership area yet, then click here to sign up for a free trial (only a name and email address required). It’s not just trade ideas. It contains research far beyond the blog as well as members-only charts, systems (with code included), and custom indicators.

2nd 90% Day Suggests Real Strength

Thursday the market again posted a day where 90% of the volume went to the upside. This follows Tuesday’s 90% up day. I looked back to 1970 at other times the market put in 2 90% days in a 1-week period. Instances are small, so it’s dangerous to rely too much on the results, but you’ve typically seen very strong moves after these tandems of 90% Up Volume days. Below I’ve listed all the occurrences along with the 20-day return of the market after such occurrences. (Results based on $100k per trade.)

It’ll be interesting to see which 90% study wins out (click here for other 90% study from 2 days ago). While a short-term pullback seems likely here soon, I am seeing more indications of further strength than I am weakness.

CBI Drops to 3 - Now Neutral

In my March 3rd post I noted my Capitualtive Breadth Indicator (CBI) rose to extreme territory. It hit 12 on the afternoon of March 2nd and peaked at 18 the next afternoon. I showed a simple system in that post that went long on a reading of 10 or higher and then exited when the CBI closed at 3 or lower.

At around 10:25 this morning the CBI dropped back to 3. Barring a huge move south for certain stocks it appears likely to close the day at 3 or 2. This would be the exit signal for the system that was described. Should the S&P manage to close above the March 2nd close off 700.82, this trade would end up a winner (up about 4.5% as I type - edit - +7% by the close).

A CBI of 3 or lower is considered neutral. There is no level for shorting. The low CBI simply means the number of stocks with potential rebound energy from capitualtive selling is small. It doesn't neccessarily suggest the end of the rally. It does mean that further gains are not helped by the bullish implications of a high CBI reading.

Why Tuesday's 90% Up Day May Not Be Bullish

Lowry’s has shown 90% days to be effective in determining market bottoms. For those who are unaware a 90% day is a day where volume and points are 90% one directional. A 90% up day would occur when 90% of the volume traded and points traded on the NYSE are to the upside.

Tuesday was a 90% up day. Lowry’s looked for cluster of them in order to determine a bottom. (You can find a free copy of their report Identifying Bear Market Botoms” here.) Unfortunately, I’ve found 90% days coming directly after a bottom tend to lead to market weakness. For the below study I ignored the points qualification and just looked for 90% up volume days.

(click to enlarge)


Both 1 and 8 days later all of the instances saw the S&P trading lower. Interestingly, while the test went back to 1970, 6 of the 8 instances found have occurred in the last 2 years. Prior to that it was unusual for a 90% day to occur directly following a low.

Light Volume Bottoms Study Part 2

In the March 6th blog I showed a study that looked at 50-day lows occurring on heavy volume (highest in 5 days) and light volume (lowest in 5 days). A 50-day low on light volume was found to be significantly more bullish. On Monday the market made a new low on the lightest volume in 5 days.

Unfortunately when I went through some of those studies Monday night I realized something quirky was happening in Tradestation. I had run them using imported volume data that went back to 1992. I also ran them on the Tradestation volume data from 1992 – present. I did this to check and see that the sets were similar. Upon finding they were I removed the 1992 – present restriction and looked back from 1960 – present. When I did that for some reason the tests ran improperly and they continued to only look back as far as 1992. There’s good news and bad news associated with this. The bad news is that when looking back further the numbers aren’t quite as enticing. The good news is that with a larger data set I was able to examine 200-day lows as well.

So here are the 50-day low numbers all the way back to 1960. First looking at high volume:

(click on any table to enlarge)


Still an edge, although a bit weaker from an Avg Trade standpoint. The last 16 years or so that were looked at last week have done better than the long-term average.

Now let’s look at low volume.



The edge here again isn’t nearly as pronounced when looking across the longer period as it was from 1992 – present. It is still quite a bit better than the high volume scenario though.

With the added data I was able to run 200-day moving average data back to 1960 as well. Again I’ll show the high volume scenario first:

Not much of an edge here. Perhaps a slight upside tendency. Next is again the low volume setup, but now using the 200-day low.

Here the edge appears fairly solid. When I looked at it in more detail I found that the bullish edge really began to exert itself around 1977. Below is a test only going back that far:

Instances are a little light but the results here are very strong.

Can The Market Bottom On Light Volume?

One common misconception about steep selloffs is that they need to be accompanied by high volume in order to mark a bottom. October 10th and (to a lesser degree) November 20th, 2008 are two examples of big down days that came on big volume that soon led to a reversal. While this pattern can precede a bounce, you’d much rather see your new low accompanied by very low volume than very high volume.

Let’s look at some studies to illustrate this claim. First let’s look at performance following a 50-day low that has neither very high nor very low volume: {edit: the following tests were inadvertently run from 1992 - present, not 1960 - present. See March 10th follow-up blog for more details and longer-term results.}

(click to enlarge)


So this is the base case and as you can see there is a slight upside edge over the next 1-20 days.

Now let’s look at the ever-popular high volume selloff:

(click to enlarge)


Results here are nearly indistinguishable from the base case. The high volume, while not a deterrent, does not seem to provide an additional edge.

Now let’s look at the less common case of a 50-day low occurring on light volume:

(click to enlarge)


While the number of instances is less than desired these results are clearly superior to the other scenarios. Over 90% winners after both 4 days and once you get out over 3 weeks. The average trade over the next week and over the next 4 weeks is about 4 times the size of the base case. While they didn’t all mark the exact low, some success stories included 10/7/02, 3/10/03, and 1/24/05.

There are plenty of technical reasons we should see a strong rebound soon. Thursday’s light volume can be added to the list. Now let’s just hope the market stops ignoring these reasons.

Breadth Indicators With Confirming Extremes

Yesterday I noted my Capitulative Breadth Indicator (CBI) spiked above 10 up to 12. On Tuesday the number reached even higher to 18. Eighteen is an extreme reading that has only been reached during 5 other periods since 1995.

Before I show those dates I want to mention another breadth indicator I look at which also measures oversold breadth. Worden Bros. T2114 and T2116 measure the % of stocks trading 1 and 2 standard deviations below their 40-day moving average. Both are in extreme territory at the current time. T2114 (1 standard deviation stretch) is reading almost 87% currently. Data is available back to 1986. Since then there have only been 6 other periods where similar levels were reached.

Below is a table comparing the CBI>=18 to a Worden Bros. T2114 > 85:

Both indicators are now at similar extremes only reached during some sharp selloffs that resulted in sharp rebounds.

CBI of 12 Suggests Bounce is Near

I’m beginning to see some indicators hit truly extreme readings – most of them breadth indicators. One indicator I track that finally spiked up to an extreme reading Monday is the Capitulative Breadth Indicator (CBI). It now stands at 12 and could spike quite a bit higher on Tuesday if the market fails to rally. I’ve discussed in the past that there is a strong bullish edge when the CBI moves over 10. A “system” I’ve discussed in the past is buying the S&P when the CBI reaches 10 or above and then selling when it returns to 3 or lower. This system was perfect from 1995 until July 2008. In July it suffered its 1st loss and in October it suffered its 2nd loss. November spike above 10 nailed the bottom and turned into the a 19% gain - the biggest ever for the system. Some detailed statistics are below ($100k/trade, 1995-present):



The CBI is one indicator suggesting a bounce is near.

For more detail on the CBI, click the label below or click here to read the intro post.

My Take On The VIX

Another big day down today and still the VIX isn’t stretched. An observation I’ve seen several traders make is that while the S&P fell hard last week, the VIX (and VXO) didn’t rise. The interpretation by some is that this suggests a lack of fear and is short-term bearish. I was unable to find evidence to support this theory. Below is one test I ran that looked at other times the S&P fell at least 2.5% while the VXO also fell.



I wouldn’t call the results bullish but I wouldn’t call them bearish either. I would suggest that perhaps the VIX is simply an indicator lacking a solid edge for the time being.