TRADING THE ODDS

On Thursday last week the SPY fulfilled the bullish setup (see my posting ‘Overbougth’ w/strong Uptrend) which was triggered on the close of Monday, January 11 when the SPY closed lower on a session after 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 the day before (both on the same session), indicating a strong underlying uptrend and forecasting at least one higher close above the trigger day’s close over the course of the then following five sessions (but regularly three sessions later), see table below.

But although since 01/01/2009 the SPY always posted a higher close (than the trigger day’s close, in this event last Monday’s close) 4 and 5 sessions later, it was the first occurrence (since 01/01/2009) that the SPY was trading below the trigger day’s close 4 (and probably 5 as well) sessions later (see stats below), which could be an early indication that upside momentum is waning and and the market could’ve reached a short- or intermedium term top.

On Friday (which coincidenced with a session immediately preceding a long weekend, the release of the Consumer Price Index and Option Expiration Friday), the SPY lost -1.12% on the close which triggered another interesting setup.

Table I below shows the SPY‘ historical performance (since 01/01/1990) on the then following session after the SPY had lost at least -1.0%

• Setup 1: on any session,
• Setup 2: on the close of a session immediately preceding an exchange holiday during the Tuesday to Thursday timeframe (means a one-day gap between two sessions),
• Setup 3: on the close of a session immediately preceding a regular weekend (means a two-day gap between two sessions),
• Setup 4: on the close of a session immediately preceding a long weekend (an exchange holiday on a Friday or Monday, means a three or more -day gap between two sessions).

Interesting to note that while the market in general shows a statistically significant (the respective t-score exceeds the +1.645 mark for statistical significance, means there is a low probability that this positive effect occured by pure chance only) short-term mean-reversion tendency (especially with respect to those occurrences immediately preceding an exchange holiday during the Tuesday to Thursday timeframe, with 5 out of 5 higher closes), the opposite applies to those occurrences which fell on a session immediately preceding a long weekend (5 higher and 14 lower closes the next session).

With the setup’s Distribution of Returns at 22.69% (means one half of the setup’s returns fell in the lowest quartile of the SPY‘s at-any-time returns), and Top 10% Losers (disproportionately high) at 31.58% (means 31.58% = 6 occurrences) falling into the SPY‘s worst 10% performing sessions, this setups shows a significantly negative tendency on the then following session (in this event on Tuesday, January 19), although 19 occurrences only is something to be careful to read anything statistically significant into it.

Table II below now shows the SPY‘ historical performance (since 01/01/1990) over the course of the then following 1 to 5 sessions when the SPY closed lower at least -1.0% on a session immediately preceding a long weekend (setup 4).

Looking up to five sessions ahead, there is a slight improvement only in comparison to the negative tendency on the then following session. With 58.89% the respective probability for at least one higher close (than the trigger day’s close) over the course of the then following five sessions significantly undercuts the at-any-time probability of 79.62% for at least one higher close over the course of the then following five sessions.

Table III below now shows the SPY‘ historical performance (since 01/01/1990) over the course of the then following 1 to 5 sessions when the SPY closed lower at least -1.0% on Option Expiration Friday.

And even when the SPY had lost at least -1.0% on the close of Option Expiration Friday (unfortunately again a small sample size only), historical probabilities and odds show a negative tendency over the course of the then following five sessions (although not statistically significant, but neither probabilities for a higher close nor the median trade and/or Distribution of Returns favor the long side in any way) .

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And last but not least some intraday stats (Table IV) concerning those historical occurrences (since 01/01/1990) where the SPY closed lower at least -1.0% on Option Expiration Friday or lower at least -1.0% on a session immediately preceding a long weekend.

It is remarkable that on the then following session the SPY

• was trading at a lower level (than the previous session’s close) at the end of the first hour on six out of every ten occurrences,
• managed a higher high than the previous session’s high on only 1 out of every 5 occurrences (19.15%) the next day, significantly lower (to say the least) than the at-any-time probability for a higher high of 51.93%,
• posted a higher low on two out of every three occurrences  (29.35%), significantly lower than the at-any-time probability for a higher low of 52.66%,
• closed above the previous session’s high on only one out of every 10 occurrences (10.64%), significantly lower than the at-any-time probability for a close above the previous session’s high of 29.35%, and finally
• the Distribution of Returns (the percentage-rank of the medium trade) and Top 10% Losers (the percentage-wise number of occurrences falling into the bottom one-tenth of the worst performing at-any-time sessions) on almost all intraday performance stats show a statistically signifcant tendency for a temporary follow-through of Friday’s weakness.

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Bottom line: With some serious weakness (a loss of at least -1.0%) on a session immediately preceding a long weekend and/or on Option Expiration Friday, and taking into account that the SPY broke it’s recent streak of 10 consecutive higher closes (all since 01/01/2009) four and five sessions after the he SPY‘s 2-day RSI closed above 96 (a so-called ‘overbought‘ market) and Wilder’s 2-day DX (Directional Movement Index) closed above 95 (indicating a strong underlying uptrend), historical probabilities and odds are (significantly) tilt in favor of some follow-through of Friday’s weakness during the (shortened) next week. A short-term pullback to the upside on Monday’s/Tuesday’s GLOBEX and/or right at the start of Tuesday’s regular session might provide a favorable short-term opportunity on the short side of the market (2 to 3 session timeframe).

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.

The post had to be updated due to a data issue – the dates shown in setup S5 were the FOMC announcement days, not the pre-FOMC announcement dates – (thanks to a reader), but the positive outlook with respect to Tuesday’s close will not change due to the fact that the ‘real’ pre-FOMC announcement days show a significantly above-average positive tendency on the close as well. I’m sorry for the necessary update.

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It seems the best bears can hope for these days is a temporary setback of a couple of index points sometime during the session (and a flat, at the utmost a slightly lower close).

An otherwise reliable sell signal (the S&P 500 closed higher on Triple Witching Friday) – 18 lower closes out of the last 22 occurrences – was more or less flattened by a recently bullish setup (S&P 500 TRIN closed above 1.50 in regularly negative territory despite a higher close for the S&P 500) – 12 higher closes out of the last 13 occurrences since 07/14/2009 – (see my posting Trading the Odds on Monday – September 21, 2009), but at least it formally complied to historical probabilities and odds and will show 19 out of 23 lower closes the next time the Triple Witching Friday setup will be triggered.

On Monday’s session the ES E-MINI S&P 500 opened lower -0.57%, posted an intraday low of -0.85% below and an intraday high of +0.16% above Friday’s close, and finally closed almost unchanged -0.07% on the day, while the Nasdaq 100 closed up +0.37% (S&P 500 -0.37%, DJ Ind. -0.42%, Russel 2000 -0.31%, SOX Philadelphia Semiconductor Index -0.02%, BKX Philadelphia Bank Index -0.48%).

Market breadth in S&P 500 stocks was mixed (but showed a positive divergence, see setup S4 below), with S&P 500 Advancing Issues/Declining Issues at 0.42 and Advancing Volume/Declining Volume at 1.00 (S&P 500 TRIN / Arms Index at 0.42). Block trades with an up tick (almost) matched block trades with a down tick, and volume on block trades with an up tick matched volume on block trades with a down tick as well on the second consecutive session (the difference falls below +/- 2%).

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Notably on Monday’s session were the facts that

• Setup S1: the ES E-MINI S&P 500 posted a lower close on the 3rd consecutive session,
• Setup S2: the ES E-MINI S&P 500 closed almost unchanged on the 3rd consecutive session (within a +/- 0.25% range),
• Setup S3: the ES E-MINI S&P 500 closed almost unchanged +/- 0.50% on the 3rd consecutive session while trading at or near a 50-day high (max. -2.5% below),
• Setup S4: S&P 500 TRIN closed below 0.50 (in regularly positive territory) despite a lower close for the S&P 500, and
• Setup S5: the next session (September 22) will be an pre-FOMC announcement day.

Table I shows the ES (E-MINI S&P 500) performance (since 01/01/1990) on the next session (in this event Tuesday, September 22) immediately following those sessions where setups S1 to S5 listed above had been triggered in the past.

(Almost) all of those setups listed above are agreeing concerning their at least slightly positive outlook on the then following session, and especially setup S1 and S5 provide a statistically relevant edge on the long side of the market (the associated t-score is close to or exceeds the +1.645 mark for statistical significance).

If you’d like to take a deeper dive into trading the markets based on statistical analysis, take a look at David Varadi’s blog CSS Analytics (highly recommended).

Table II shows the ES E-MINI S&P 500 intraday performance (since 01/01/1990) concerning the open, the first hour of the session, the last hour compared to the first hour (means the ES‘ performance between the end of the first hour and the start of the last hour of the session), the last hour of the session and the close (in chronological order) on those sessions (in this event Tuesday, September 22) where S5 (the next session will be an pre-FOMC announcement day) had been triggered in the past.

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Bottom line:

At least based on historical probabilities and odds and the market’s regular performance on those sessions after any of setups S1 to S5 had been triggered on close of the previous trading day, the outlook concerning the ES E-MINI S&P 500 performance on Tuesday, September 22 is positive.

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).

Disclaimer: No position in the securities mentioned in this post at time of writing (but short volatility).