TRADING THE ODDS

(ES E-Mini S&P 500) Futures are currently down -0.75% at time of writing (01/12/2010 09:11 AM) forecasting a potential (probably) lower close today (Tuesday).

But although a lower close today seemed likely (after a streak of higher closes, a series of higher highs and higher lows and the market’s ability to shrug off early weakness posting a higher close), any significant weakness today might provide a short-term buying opportunity.

Table I below shows the SPY‘ historical performance (since 01/01/1990) over the course of the then following 1 to 5 sessions when the SPY‘s 2-day RSI closed above 96 (a so-called ‘overbought‘ market indicating that it’s becoming increasingly difficult to find the ‘greater fool’ willing to buy your shares for an even higher price) and Wilder’s 2-day DX (Directional Movement Index, not to be mistaken for the Average Directional Movement Index (ADX)) closed above 95 (on the same session) indicating a strong underlying uptrend.

Interesting to note that upside potential on the then following session (today) was regularly limited (max. gain +0.51% the next day despite the run-up in the markets), but at least during 2009 the index always posted a higher close (than the trigger day’s close, in this event Monday’s close) 4 and 5 sessions later (but regularly already 3 sessions later) providing a short-term buying opportunity. So the timeframe between Friday this week and Monday next week might indicate if the recent run-up in the markets might persist for the time being …

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.

Tuesday’s session raises the question if a pullback or a follow-through (of the previous session’s strength) immediately following a strong up-day (like on Monday, September 28) would be a positive or negative indication for the then following session (in this event Wednesday, September 30).

I therefore checked for those occurrences where

• Setup S11: the ES E-MINI S&P 500 left an unfilled opening gap on the upside (like on Monday, September 28) and closed lower the next session (today ?),
• Setup S12: the ES E-MINI S&P 500 left an unfilled opening gap on the upside (like on Monday, September 28) and closed higher the next session (today ?),
• Setup S13: market internals (breadth) were heavily lopsided on the upside (at least 90% of S&P 500 stocks closed higher, like on Monday, September 28), and the ES E-MINI S&P 500 closed lower the next session (today ?),
• Setup S14: market internals (breadth) were heavily lopsided on the upside (at least 90% of S&P 500 stocks closed higher, like on Monday, September 28), and the ES E-MINI S&P 500 closed higher the next session (today ?),
• Setup S15: the ES E-MINI S&P 500 closed up at least +1.75% (like on Monday, September 28) and lower on the then following session (today ?),
• Setup S16: the ES E-MINI S&P 500 closed up at least +1.75% (like on Monday, September 28) and higher on the then following session as well (today ?),

Table I shows the ES (E-MINI S&P 500) performance (since 01/01/1990) on the next session (in this event Wednesday, September 30) immediately following those sessions where setups S11 to S16 listed above had been triggered in the past.

It is especially remarkable that with a lower close on the session immediately following a strong up-day (setups S11, S13 and S15),

• the probability for a higher close on the then following session (in this event Wednesday, September 30) – partly significantly – exceeds the respective probability for a higher close in the event of another higher close immediately following a strong up-day,
• the odds (profit factor, average trade, t-score) on the then following session (in this event Wednesday, September 30) significanty undercut the respective odds in the event of another higher close, and finally
• with respect to setup S11 and S15, the respective t-scores signifcantly exceed the necessary -1.645 mark for statistical significance on the downside, means there is a low probability that those negative returns occurred by chance only.

Picture 1 shows distribution of the ES E-MINI S&P 500′ performance (gains and losses, close compared to the previous session’s close) on the then following session (in this event Wednesday, September 30) where any of setups S12, S14, S16 (another higher close immediately a strong up-day) listed above had been triggered on close of the previous trading day (overall bias). Although more data points (percentage performance numbers) fall to the left of the middle (negative closes), there are more exceptionally large than exceptionally small values (above +2.0%).

Picture 2 shows distribution of the ES E-MINI S&P 500′ performance (gains and losses, close compared to the previous session’s close) on the then following session (in this eventWednesday, September 30) where any of setups S11, S13, S15 (a lower close immediately a strong up-day) listed above had been triggered on close of the previous trading day (overall bias). Although more data points (percentage performance numbers) fall to the right of the middle (positive closes), there are more exceptionally small than exceptionally large values (below -2.0%).

Bottom line: In the event of a lower close today (Tuesday’s session), by going long on today’s close there is a slightly better than random chance that you’ll be ‘right’ on Wednesday’s close (but you’d be losing money in the long run), but if your primary goal is to make money in the markets, a higher close today would be the preferred outcome with respect to Wednedays’s close even if this would lower your probability of being ‘right’.

Successful trading,
Frank

P.s.: I’ll regularly make some intraday updates as well using Twitter. If you’re interested in, please have a look at the blog during the trading session as well (Twitter updates are shown on the upper right section of the blog) or subscribe directly to Twitter (recommended).

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Disclaimer: 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. Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security. No position in the securities mentioned in this post at time of writing.