Daily Commentary - Posted on Sunday, March 21, 2010, 5:22 PM GMT +1

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Mar Sunday 21

O|H|L|C Probability and Profitability (Part I)

Although the efficient-market hypothesis claims that prices of financial assets always exhibit random walk behavior and thus can not be predicted with consistency, history shows that there are a couple of favorable setups based on daily open|high|low|close prices of an asset which stood the test of time and may be part of a potential market timing strategy.

Part I today deals with those setups (based on price alone) which – from a longer-term and more recent history – showed a favorable opportunity on the long side of the market, while part II will deal with those setups which historically showed a favorable opportunity on the short side of the market. Part III at a later stage will take a deeper dive into favorable combinations of  setups on the long and short side of the market (e.g. x consecutive sessions where the SPY posted a higher high and a lower low on the same session), and part IV will deal with favorable opportunities on the long and short side of the market over the course of the then following x sessions (e.g. probability and profitability for at least one higher/lower close over the course of the then following 1 – 3 sessions after a respective signal had been triggered in the past).

Table I below shows the SPY‘s historical (since 01/01/1990) performance (number of occurrences, % of winning trades, median return, cumulative return) on the then following session (next day returns) immediately following a session where one of the following setups (‘Setup‘) had been triggered on a number of (bandwith checked for: -25 … +25) consecutive sessions (‘Streak‘) in the past, assumed one would’ve bought the SPY on close of a session where the respective setup (see list below) had been triggered:

Setup 2: today’s open above (+1) / below (-1) below the previous session’s close
Setup 3: intraday high vs. previous session’s close (if negative: unfilled opening gap down)
Setup 4: intraday low vs. previous session’s close (if positive: unfilled opening gap up)
Setup 5: close vs. previous session’s close
Setup 6: open vs. previous session’s open
Setup 7: open vs. previous session’s high
Setup 8: open vs. previous session’s low
Setup 9: intraday high vs. previous session’s high
Setup 10: intraday high vs. previous session’s low (if negative: unfilled gap down)
Setup 11: intraday low vs. previous session’s low
Setup 12: intraday low vs. previous session’s high (if positive: unfilled gap up)
Setup 13: close vs. open
Setup 16: close vs. previous session’s open
Setup 17: close vs. previous session’s high
Setup 18: close vs. previous session’s low
Setup 19: intraday high vs. intraday low (intraday range)
Setup 20: during the first hour (price at 10:30 am vs. 09:30 am)
Setup 21: end of first hour (price at 10:30) vs. previous session’s close
Setup 22: start of last hour vs. end of first hour (price at 3:00 pm vs. 9:30 am)
Setup 23: start of last hour (3:00 pm) vs. previous session’s close
Setup 24: during the last hour (4:00 pm vs. 3:00 pm)
Setup 25: close vs. intraday range

Table I and II below itemizes only those occurrences and setups where the probability of a winning trade historically exceeds 66.67%. A positive streak indicates a respective number of consecutive sessions with a positive return / higher close /close above … and vice versa.

How to read the stats:
(e.g. the fourth line): since 1990 there were 17 occurrences (# Occurr.) where the SPY opened below (Streak = -5) the previous session’s close (Setup 2) on 5 consecutive sessions (‘Streak‘). The SPY closed higher on the then following session on 70.59% (= 10 sessions) of all occurrences, showed a respective profit factor of 6.47, a median return of +0.3956% and cumulative returns of 25.73%. A streak of ‘0’ means ‘unchanged’ (e.g. the SPY did not open above/below the previous session’s close, but opened unchanged).

Table I
(01/01/1990 – today)

From my perspective, some of the most interesting findings are:

  • It’s not always buying weakness which shows the highest probability and/or profitability for a higher close on the then following session, but buying strength as well; 15 out of those 44 favorable opportunities on the long side were triggered after a long streak of positive returns (e.g. going long after a streak of 9 consecutive sessions where the SPY opened above the previous session’s close),
  • long-term, setup 10 (an unfilled gap down) and 12 (an unfilled gap up) did never provide a favorable (from a probabilties perspective) opportunity on the long side, even after a streak of x consecutive sessions with an unfilled gap up/down.

Due to the fact that the market(s) showed a different behaviour during the 90th (trend-following was the dominant theme) and 20th (short-term mean reversion was/is the dominant theme), Table II below now shows the SPY‘s historical (since 01/01/2000) performance (number of occurrences, % of winning trades, median return, cumulative return) on the then following session (next day returns) immediately following a session where one of the following setups (‘Setup‘) had been triggered on a number (bandwith checked for: -25 … +25) of consecutive sessions (‘Streak‘) in the more recent past, assumed one would’ve bought the SPY on close of a session where the respective setup had been triggered:

Table II
(01/01/2000 – today)

From my perspective, some of the most interesting findings are:

  • especially three consecutive closes below the previous session’s low (setup 18) provided a favorable entry on the long side of the market (with respect to the raw number of occurrences, the respective probability for a higher close on the then following session, the profit factor and median trade), likewise during the 90th and 20th,
  • 2 consecutive sessions with an open above the previous session’s high (setup 7) are a more recent (bullish) appearance; this setup didn’t make it in the long-term list (Table I, since 1990), but showed one of the more favorable opportunities on the long side since 2000,
  • setup 11 where the SPY posted a series of 5 consecutive sessions with a low below the previous session’s low is one of the most favorable setups. It shows a relatively high number of occurrences (35 since 2000), a winning percentage in excess of 70%, and most interesting a median return on the then following session of almost +1.0%. Next to setup 11 is setup 23 where the SPY posted a series of 5 consecutive sessions trading below the previous session’s close going into the last hour of the session, closing higher the next session on every 3 out of 4 sessions with a median return in excess of 1.0%, and finally
  • it’s not always buying weakness which shows the highest probability and/or profitability for a higher close on the then following session, but buying strength as well; more than 50% (29) out of those 57 favorable opportunities on the long side were triggered after a long streak of positive (the so-called ‘overbought‘ conditions) instead of negative returns (e.g. going long after a streak of 2 consecutive sessions where the SPY opened above the previous session’s high).

Successful trading,
Frank

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Disclaimer: No position in the securities mentioned in this post at time of writing.

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

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