This 3-Day Pattern Is Suggesting Caution For Today

After Wednesday’s move to a new high, Thursday put in an inside day.  With Friday closing at another new high the study below triggered, which I have only previously shared in the Subscriber Letter.  It showed that SPY closed down the next day 13 of that last 15 times following a 50-day high, then an inside day, and then another 50-day high.  Below I have listed all 15 instances.

Risk/reward here heavily favors the short side. The average drawdown is slightly over 4 times the size the average run-up. Also notable is that every instance saw drawdown of at least 0.35% the next day, but only 1 of the 15 instances saw run-up of at least 0.35%. Traders may want to take this into consideration for the upcoming day.

Revisiting Consistently Strong Closes

The market has seen a lot of finishes near the top of its daily range lately.  When the market consistently closes near the high of the day it suggests optimism on the part of traders. This end-of-day optimism is now at a level that suggests it is overdone and there is a good chance of a pullback. The study below was last seen in the 1/16/13 blog and it exemplifies this concept. I have updated all of the statistics.

While the downside edge appears to remain in place for a full week, most of the edge has been realized over the 1st 2 days.  Below is an equity curve showing how the edge has played out using a 2-day exit strategy.

The strong downslope appears to confirm the bearish edge, even with the action of the last few instances.



Note: To calculate the “8-day Average Closing % Range” I am simply measuring where in the daily range SPY closed each day. For instance if it traded at a low of $146.00 and a high of $147.00 and closed at $146.75, then it would have closed in the 75th percentile of the daily range. A close at $146.50 would have meant 50%.

I then take a simple moving average of the last 8 days. If that average goes from below 75% (where it usually is) to above 75%, the study is triggered.

What Monday's Weak Breadth Could Foreshadow

Monday’s weak breadth could imply negative ramifications over the next few days.  In the past I looked at instances where the SPX closed higher while the NYSE Up Issues % came in under 40%. Results above the 200ma showed a steady and persistent downside edge. I have updated them below.

The numbers here appear to suggest a downside edge.  Perhaps the market is readying to lay off the gas for a day or two.

This Pattern Suggests We Could See More Upside In The Next Few Days

Short-term strength is often followed by short-term weakness, but when that short-term strength is unusually impressive, it can create a situation where that extreme strength will beget more strength. When the market leaves an unfilled up gap that is considered a sign of strength.  When it does it 2 days in a row and closes at a 50-day high, that can be considered exceptional strength. That is what happened on Friday, and it triggered the study below, which I last shared on the blog on 9/10/12.  All stats are updated to present day.

The size of the follow-through isn't terribly large. But it has been very, very consistent that at least some follow through was achieved in the next few days.

What Happens After 6 Months Of Gains

April marked the 6th month in a row that SPX has managed a positive close.  I have seen many analysts suggest this means the market is overextended and due to correct in the coming months.  So I decided to take a look for myself.  I ran a study to examine past performance following 6 consecutive months of gains.

The 1st month out of the gate looks to have about breakeven odds.  After that everything points to the bullish case, with strongly positive stats across the board for the next 10 months or so.  In fact, 10 months out all 14 instances were higher.  Below I have listed the 14 instances.

Some strong results here.  Based on this, it appears that the bulls should be celebrating that 6-month rally, rather than the bears trying to use it as evidence for an overdue pullback.

Of course there has also been a lot discussed about “Sell in May” and the possible weak upcoming seasonality.  I did a detailed study on this in the intermediate-term section of the Subscriber Letter this past week.  If you would like to read it you may sign up for a free trial using the link below.

http://www.quantifiableedges.com/members/register.php

The Impact Of A Breakaway Gap

In the 9/7/12 blog I looked at the short-term importance of an unfilled upside gap accompanying a breakout.  With yesterday’s breakout to a new closing high occurring along with an unfilled up gapI have revisited that study below.

Results here are strong across the board.

Now let’s look at instances where the 50-day high breakout was not accompanied by an unfilled gap.  Interestingly, the number of instances was nearly the same.  This study also appeared in the 9/7/12 blog.

As you can see these moves to new highs that don’t start with an unfilled gap are much less reliable over the short-term.

Technicians will often use the term “breakaway gap”.  This suggests the gap occurs on the same day as a base breakout.  The idea is that the new high causes excitement and the gap leaves a good amount of people sidelined or stuck short.  When it doesn’t immediately fill, it leads these people to chase and helps to propel the market even higher.

Interestingly, as I showed yesterday on Overnight Edges, breakaway gaps like this have not led to a positive overnight session.

What Recent Moves Up Suggests About The Pullback That Began On Friday

Strong, persistent moves often do not roll over immediately.  Real persistency can set up a situation where strength begets more strength.  An example of that concept was triggered with Friday’s setup, where we had the 1st down day after 5 consecutive higher closes.

Initially there appears to be a moderate inclination for a bounce.  Once you get out 9-10 days the upside edge appears very substantial.  Based on this, there appears a good chance that the dip that started Friday may not get too far before the market again moves higher.