Flat-lined

After shooting up 3.5% last Tuesday the S&P 500 has flat-lined. The chart might make you think there was a takeover announced last Tuesday morning of all 500 components. Volume has dropped each day as well.

I looked back over the last 30 years for similar price action. The only other time the market followed a gain of 3% or more with 3 consecutive closes within 0.25% of the close of the 3% day was December 3, 1982. By lowering the requirement of the surge day from 3% to 0.75% I was able to get a larger sample size. A summary of those instances is in the table below.


One day out falls basically in line with random. Two to three days out there appears to be a slight upside edge when this occurs.

Below are the results if you eliminate the surge day all together and just require the coiling action to occur above the 10-day moving average.


Again, slightly better than random over the 1st three days. Nothing to exciting here, but another small hint at higher prices.

What The Low VIX May Be Indicating

With all the recent volatility in the market, many traders have noted the recent low VIX levels and wondered if that was a sign of complacency. Low VIX readings relative to their short-term moving averages do sometimes presage market pullbacks. While one use of the VIX is trying to predict the direction of the market. That really isn’t what the VIX represents. It represents options traders perception of future volatility. So perhaps the low VIX means they know something?

One of the most unusual aspects of the recent environment is how volatile it has been in a virtually trendless market. Wild swings within a range. Lots of chop. To quantify this action I took the 14-day ADX of the SPX (15.56) and divided it by the 14-day historical volatility (volatilitystddev in Tradestation terms), which currently stands at 0.3023. The result (about 51) is what I call trend over volatility (TOV). Charting this helps to see other times where volatility was high and the market wasn’t trending.

Going back to 1960 I was only able to find 5 other periods where the TOV was below 55. Looking at the performance of the market “X” days out gave the following results:


Four pretty strong winners and one sizable loser. Interesting, but perhaps not compelling enough for a directional bet on its own. (Combined with my other recent studies it may be.)

To try and glean a little more I looked at the charts. The top line is TOV. The yellow line is ADX. The blue line is Historical Volatility. The vertical line shows when the TOV dropped to 55 or lower. (Click charts to enlarge.)

October 2002

January 2001

February 1999

January 1988

October 1987

The one thing that stuck out to me? In every case, at some point in the next month there was a sharp drop in historical volatility. In ’87 and ’88 it took about 3 weeks. The other times it was almost immediate. Does the VIX know something? It just might.

Perhaps those uncomfortable with directional bets in the current market might prefer to use options and bet on a reduction in volatility.

I haven’t done too much with this indicator yet, but I suspect it could have applications for individual stocks as well.

Tradestation users who wish to play with this indicator and concepts more may purchase and download the indicator, study, and workspace at the studies section of the Quantifiable Edges website for $12.00. I made the inputs for length on both ADX and Historical Volatility flexible so that it can easily be fine tuned.

Will The Employment Report Cause Large Range Expansion?

Compared to the recent volatility the last two days have been very tame. One line I’m hearing is that traders didn’t want to take big bets before Friday’s employment report. The expectation seems to be that the employment report will spark a big move Friday one way or the other.

To test this I compared the 2-day average true range with the 20-day average true range. The ratio as of Thursday’s close in the SPY was about 0.53. I ran a test to see what happened when this ratio had dropped below 0.55 or lower going into a report. The basic expectation was that the contraction in volatility would reverse after the news was released and lead to an explosion in volatility.

That did not hold true. The table below shows the results.


The third column shows the true range on the day of the release vs. yesterday’s 20-day average true range. The average for the 9 instances was 0.94 – meaning the true range after the report failed to reach even average size (1). In the last column I showed the percentage gap that SPY opened the next morning.

You’ll probably hear a lot of hype about the importance of the number Friday morning. Don’t be too surprised if it turns out to be just that – hype. Historically after such contractions it hasn’t led to the volatility explosion that you might expect.

If you would like to explore the action leading up to and on employment days in more detail and you use Tradestation, you may purchase the study here.

How Markets Really Work - Free

I've had the pleasure of doing some work with and for Larry Connors. His ideas have inspired a good amount of the work I've done over the last several years. I've mentioned before his book "How Markets Really Work", which has many interesting facts and observations in it. When I went to the TradingMarkets site today I noticed they were allowing free downloads of the book until Monday night. I'd highly recommend people download and read it. Here's the link:

How Markets Really Work

Consolidating Gains

Today’s action didn’t appear spectacular in any way. The market consolidated its gains on ho-hum volume. While my blog yesterday indicated Tuesday’s big gains served as further confirmation that the market was likely to continue higher for at least a few weeks, the short-term is not as bullish. Most of the time there is some brief give back after such large moves.

I ran some numbers tonight looking at action immediately following up days of 3.5% or more in the S&P 500. Of the 35 instances since 1960 that my scan found, 31 of them traded lower than their thrust day close at some point in the next 5 days. (Make that 32 for 36 after Wednesday.) 18 of the 35 traded lower by 1.75% or more.

What’s this tell me? The pullback today was normal. In fact, continued pullback would be normal. The last two big thrust days (3/11 and 3/18) the market fell hard and fast almost immediately. If the market can get through tomorrow without a sharp selloff, that could be a positive. It would be a change in character.

Some Historical Comparisons

On Tuesday the SPY gapped up over 1.25%. Hopefully readers of the blog recalled that this was not a signal to either go short or take profits on longs. Large gaps up during downtrending markets have a tendency to trap shorts and lead to further intraday gains. This was the case today as the S&P 500 and Nasdaq Composite both finished up over 3.5%.

On March 19th I ran a study that looked at market performance following two 3.5% up days in the S&P 500 within 10 trading days. Results following this type of occurrence were quite bullish over the next 2-6 weeks. There were also some major bottoms identified. Below is a copy of the results table I displayed that day (therefore it doesn’t include the March 19th, 2008 occurrence). $100,000 per trade.


Today we once again saw the 2nd day in the last two weeks to make a 3.5% gain. In fact, that now makes 3 times in 15 trading days. That has only happened two other times since 1960: October of 1987 and October of 2002. Those dates may sound familiar. I posted graphs of those two periods in my March 20th column. They were the only two times other than March 19th and 20th that saw the market rise 4% one day and then drop 2.4% the next (since 1960).

The market continues to provide incredible volatility. In the past this volatility has been associated with intermediate or long-term bottoms. There was probably a fair amount of short covering today. There was also probably a fair amount of short covering in October 1987 and October 2002.

On its own it would be very dangerous to read too much into a study with just two prior occurrences. Taken together with all of the previous intermediate-term studies I’ve referenced over the last few weeks, today’s action acts as confirmation that the market should put in generally higher prices over at least the next several weeks.

If you use Tradestation and would like to purchase and download tonight’s study, you may do so here. (It’s also included in the March 19th package.)

Stuck In The Middle & An Announcement About Studies

I ran several different studies tonight all of which told me basically the same thing…nothing. From a short-term perspective I am not seeing much in the way of an edge. Let me quickly illustrate why. Below is a 60-minute chart going back to January.


Seems like a lot of movement to go nowhere. The market is right smack dab in the middle again. Rather than try and pick sides here, I’d prefer to wait for a clearer edge.

One notable about tomorrow is that it is the 1st day of the month. Since 1995 the first day of the month has been profitable about 2/3 of the time. (Before that there was no discernable edge.) More details on “1st day of month” can be found here.

I have several new things in the works right now, including a volume study that I hope to complete and release in the next week or so. As some of you may have noticed, I am now making the studies available for Tradestation users to purchase and download. By sometime this weekend I hope to have nearly all studies for Q1 available. I will be offering packages of the studies so that people may either examine the ideas further or use them as templates in conducting their own research.