Tuesday, April 15, 2008

What Happens When Range Rapidly Contracts

In the 1980’s Tony Crabel published research on Wide Range Bars and Narrow Range Bars. He introduced the concept of WR7’s and NR7’s. A WR7 is a bar whose range is wider then the previous 6 bars. An NR7 is a bar whose daily range is narrower than the previous 6 days. Others have done work with WR and NR bars since then including Linda Bradford Raschke and Larry Connors – both separately and together. Their book Street Smarts contains a pattern which uses historical volatility and NR4 bars to look for explosive moves.

The market’s steep selloff on Friday created a WR7 bar. On Monday the selling quieted and the market actually put in an NR7 day. While volatility tends to be mean reverting, it’s unusual to see it contract that fast. I look at the action in the NDX back to 1986 when a WR7 with a lower close was followed by an NR7 the next day. Buying on the close of the NR7 day and holding for “X” days achieved the following results:

It appears the inability of the sellers to follow-through after the wide range day down invites buying over the next several days. In the very-short term (1-3 days) the bias is strongly bullish. Consider the fact that the average day over the period tested was a 0.06% gain. The one day performance following this setup was over 10-times a normal day and over three days it outperformed and average three days by over 5-times. The high win rate and average win size consistently higher than the average loss make this setup intriguing.

A few other notes: 1) Whether the NR7 day was positive or negative had little impact on performance and was not differentiated in the results above. 2) A WR7 up bar is a less bullish setup – but I’ll look at that in more detail when the time is appropriate.


bzbtrader said...

Have you looked at the effect of volume on your backtest results? Monday's NDX (QQQQ) volume was lowest of the year and Friday's volume was below the 10 DSMA. Are the wr7/nr4 tests set to allow pyramiding, or must they occur sequentially in order to be counted? Enquiring minds want to know. Keep up the great work and thanks for the nuggets.

Rob Hanna said...

bzb -

I noticed the volume yesterday as well. I considered looking at it in the test, but the sample size wasn't very big, so I decided not to parse it anymore.

WR7 and NR7 had to happen back to back.


Joe said...


How can I understand this? Friday's market action would bring lower prices, while Monday's action would call for higher proces from the historic perspective. How can I understand what giveth?
Thanks, Joe

Rob Hanna said...

Joe -

Sunday night the study suggested the market would go down and Monday it did. Monday night's study suggested the market would go up. Tuesday it did. What more could you want? LOL. Just kidding.

Good question. My evaluation and interpretation of the studies is something I try and do each night in the Subscriber Letter. Currently there are 9 studies which I consider "active and exerting influence". 7 bullish and 2 bearish. It isn't unusual to have some conflict.

I'll write some posts on using the studies in the near future. A simple way to approach them would be to view each as you might an indicator. Rarely will everything line up perfectly. It is up to us take the information they are providing and use it to formulate our bias and trading plan.