Wednesday, April 9, 2008

A Rooster Egg Market

I remember a riddle from when I was a kid that went something like this:

Q: If a rooster lays an egg right at the very peak of the roof of the barn while facing north and the roof slopes east and west, which way will the egg roll?

A: It won’t. Roosters don’t lay eggs.

Now for the market:

Q: If the S&P shoots up 2.5% or more in one day and then closes within 0.5% of its closing price the next five days in a row, which way will the market break?

A: The S&P doesn’t do that…until now.

Here’s a line chart of the S&P 500.

I see no short-term edge.

In other news, Alcoa (AA) released earnings Monday night. They disappointed and sold off a little bit on Tuesday. Alcoa’s earnings release always comes with great fanfare because it’s typically the first large-cap to report after the end of the quarter. Does it really deserve all the fanfare? Is it somehow predictive of how the market may perform during earnings season? I figured it was worth a look.

The test was run as follows. I looked back at the last 25 earnings announcement for Alcoa. If Alcoa rose following its earnings announcement I bought the S&P 500 and held for 25 days. If Alcoa fell following its earnings announcement I sold short the S&P 500 and covered 25 days later. Results below broken out by buys and sells:

Buys: 9, Winners: 5, Losers: 4
Shorts: 16: Winners: 9, Losers: 7

From this limited test it appears the reaction to Alcoa’s earnings is about as important to the market as scoring first is in a basketball game.

What's a trader to do when they can't identify a clear edge in their timeframe/market? Some thoughts on what to do between trades from Dr. Steenbarger might help.

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