As the S&P500 plummeted more than 2% today (thanks Greece!), I was reminded about a question I had about the market’s tendency to revert to the mean. Specifically, does the size of the drop have any relation to the duration before rebounding? Does a bigger dip take longer to recover, like a fighter who’s received a particularly strong blow to the temple? Or does a larger downward move snap back faster, like a rubber band?
I took a look at SPY (as a stand-in for the S&P 500) from its start in 1993 to June 26th 2015. I looked at all the instances where SPY closed down below the previous day’s close, which I’ll call the ‘signal day’. And then I determined the number of days it took for the close to be above the close of that signal day. The idea here is you might want to buy SPY (or perhaps a leveraged equivalent) at the close of this down day, with some idea of how long it’s going to take for your trade to be profitable.
I looked at a ten day window only. Any signal days that required more than 10 days to recover, I assigned an arbitrary value of 11 days to that signal. Is this valid? Yes in my opinion, because it reduces outliers from the averages, and also I see this as a short-term mean reversion idea. If it’s going to take longer than 11 days to recover, you’re probably better off closing the trade and waiting for another opportunity.
I expected to see some correlation between the depth of the drop and the length of the recovery, but ya know what? I don’t see it!
The average recovery time hovers around 3 days, but note that this is skewed by outliers. The more important numbers to me are the median and mode. Across the board, for every percentile “bucket”, the median number of days to recover is “1”. That means, no matter how big the drop, you’ve got a greater than 50% chance that the next day’s close will be greater than your signal day. And with the average around 3 days, that might be a good place to set your maximum trade duration.
Seems like you could create a trading system around this, yes?
Update 06/30/15: The day after, the market closed slightly up. See? Told you so. (This one time, anyway…)
Seasonally Shorting Silver…Success! A little alliteration goes a long way.
Silver prices tend to decline during the month of June. So at the beginning of the month I bought ZSL (ProShares UltraShort Silver ETF). I just closed the position today for a gain of 11.5% before commission. Woot woot!
So why did I exit today instead of waiting until the end of the month? My reasoning was this:
a) I’d made some decent return so why not cash in?
b) Silver prices are strongly correlated to the strength of the dollar. The stronger the dollar, the cheaper silver gets. Greece could conceivably get its act together in the next few days, in which case the euro might strengthen against the dollar, and silver prices could go back up. And then I’d be smacking my forehead saying “doh!”
And yes, conceivably, Greece could get booted out of the EU, or torture everyone by stretching things out eve more, so that the dollar strengthens even more. But that’s not a bet I want to take. What with the unrealized profit and all.
c) Silver had just had a big move downward on Tuesday, so why risk a correction?
My success with this trade is tempered by two short-squeeze trades that both hit my 7% stop losses. Win some, lose some.
Seasonally, the first half of June tends to be a little dicey. That and the current market conditions have led me to keep only a light presence in the market, with a focus on some alternative investments besides stocks. I just got back from vacation, and I had stopped putting on new trades before I left. Who wants to be tied to the market while on vacation? Not me!
At the beginning of June I entered a position with ZLS (ProShares UltraShort Silver ETF), as silver prices tend to dip during the month of June. When this play is a win, it tends to do 15-20% or so. As of right now I’m up 12%, which is making my trigger finger a little itchy.
Gasoline futures tend to rise in the last week in June, through the end of July. Looks like today is getting a bump and giving me a signal, so I’ll enter into a position with UGA at the end of the day. Crossing my fingers and hoping gas prices go up! (Wait, did I just say that?!)
I’ve also been investigating short-squeeze plays . Since I don’t have access to historical fundamental data such as short ratios, I can’t currently backtest my theory. I’ve been forward-testing it for a few weeks, and also placed four trades, and so far so good(3 of 4 were wins). A friend has pointed me to a source for historical fundamental data so I might give that a go.
And lastly, I continue to use very small mean-reversion strategies, with profit targets in the range of 2% and a duration of just a few days. Seems perfect for this low-volatility, go-nowhere market we’re currently in.
Within 11 days of hitting a 20-day high close, today the S&P 500 hit a 20-day low close. When this sort of roller coaster up and down happens, what can we expect from the future? Well as I often say: “the future can be revealed with statistics! But only 60% of the time.”
So I dusted off the ol’ trading abacus and looked back through SPY, an ETF which stands in nicely for the S&P 500. I looked all the way back to 1993 because, hey, I care about you folks. And really, it was no trouble at all.
I didn’t want to overfit my sample selection, so I set up these simple parameters:
• The close of SPY must be lower than the previous 20 closing prices.
• Sometime in the past 15 days, a close was higher than the previous 20 closing prices.
This yielded 150 instances since 1993, which should be enough data to chew on. Here’s what happened over the next five days, on average, if you’d bought at the close of that 20-day low close (not including commissions etc). The result is a decidedly positive win rate for all five days following, and an all-positive average gain over all five days too.
1 day win rate
2 day win rate
3 day win rate
4 day win rate
5 day win rate
1 day avg G/L
2 day avg G/L
3 day avg G/L
4 day avg G/L
5 day avg G/L
Conclusion? You should have bought SPY at the closing bell today. But not to worry, the rest of the week could be awesome.
I track the weekly change in the Commodity Futures Trading Commission’s “Commitments of Traders” report. This report provides the number of futures contracts committed to each week by large institutional traders, hedge funds etc. While it doesn’t predict the future, it can tell you what the Big Money thinks the future will be. Sometimes that’s the same thing!
I graph a short momentum indicator of the change in the ‘long’ position from week to week. Next week looks like it might be an ‘up’ week, at least for the NASDAQ and S&P 500. The Dow shows a declining momentum, although it’s still positive. Caveat emptor.
One thing to keep in mind is that the data shows the state of the futures market through Tuesday, but the report isn’t released until Friday. So there’s a delay there, where many things can happen.
The green line is the SPY ETF, used as a stand-in for the S&P 500. The other lines are the momentum indicators.