Friday, January 20, 2006

High Volume Steep Decline: What Comes Next

Friday's market moved sharply lower, with SPY down 1.82% on volume that was 136% of its 20 day average volume. What typically happens after such a decline? I will provide a preliminary analysis here, but will follow up tomorrow with further analyses.

I went all the way back to January, 1998 (N = 2022 trading days) and found only 29 days in SPY that were down more than 1.5% on volume that exceeded the 20 day average by more than 75%. Large, high volume declines have thus been rare--especially recently. During this low volatility bull market, we've only had one occurrence: 3/10/04. The market followed that down day with a further decline of 1.3% the next trading day.

Over the next three trading days, when we've had a steep decline on large volume (N = 29), the market has been up 19 times, down 10 for an average gain of .83%. That is quite a bit better than the average three-day gain of .06% (1091 up, 931 down) for the sample overall. There is thus a tendency to rebound over the near term.

Interestingly, the day after a high volume steep decline tends to be a big day, whether up or down. Of the 29 occurrences, 19 were either up or down the next day by more than a full percent, and 8 of the 29 moved more than 2%. This reflects serial volatility: highly volatile trading days tend to be followed by days that are above average in volatility. In fact, the average absolute one day change in the sample was .92%, but the absolute one day change following a high volume steep decline was 1.56%.

More to follow...


markbrickman said...

Volatility! Whats that ??!!! Posted my best trading day yesterday in 2 years !! hope the increased volatility is here to stay. Ps. I am a trend fader with my model only executing an average of twice a week since Dec 10! Yesterday i hit 5 roundtrips with 1 monster. (Love the fear/panic days) .. thank you for this informative blog!

mark brickman
miamibeach, FL

Brett Steenbarger, Ph.D. said...

Dude, you sound like the traders I work with, some of whom hit some big home runs Friday. Thanks for the note. No question about it: low volatility tends to follow low volatility and high volatility tends to breed high volatility. So we should see some interesting trade on Monday. The traders who will get it up their backsides, however, will be those who assume that the trendy volatility of Friday will necessarily continue. High volatility trend days are the exception, not the rule, in any market--otherwise it would be a helluva lot easier for all of us to make money.

The really expert traders have a style for trading lower volatility markets and a style for trading trends and higher volatility. It's like a batter who faces a fastball pitcher one way; an offspeed curveball pitcher another way. When you have that flexibility, you don't have to hope that volatility is here to stay. You want opportunity to be a function of how *you* trade, not how the market trades.

It's snowy in Chicago and I could use a dose of South Beach just about now. Best of luck with your trading.