Monday, January 23, 2006

Narrow Bounce After a Big Decline: A Rare Occurrence


I couldn't wait to add this to the blog. Check my personal site tomorrow for details. This is a measure of institutional presence in the market that updates every 20 seconds. It correlates with daily price range by .45 since the beginning of January. Now the question is whether institutional involvement during period X will predict volatility in period Y. Stay tuned...this is getting fun.

I have received a number of email inquiries regarding indicators for assessing the likely volatility of the coming day's trade. I will post something to
my personal site shortly on this topic. Obviously such information is invaluable on days such as Monday, when all indications from Friday pointed to likely volatility. When we saw the narrow overnight range, however, followed by mediocre volume in the ES, it became clear that this was not going to be a breakout day. Being able to evaluate volatility in real time is critical, because it enables you to handicap the odds of moves breaking through ranges vs. reversing back into the ranges. As we can see from the comparison of Friday and Monday, greater volume and volatility makes the difference between a day of breakouts and a range bound day.

We followed Friday's large decline with a small gain amidst low volatility on Monday. As we saw from the previous posts, this is a statistically unusual event. When I went back to December, 1998 (N = 1793), I found how unusual this is. After a large decline of more than 1.5%, we have never--until Monday--had a rise on such low volatility. For what it's worth, small bounces from large declines that occurred on ranges of less than 1.5% (N = 8) were down the next day on six of those occasions for an average loss of -.94%. In general, lower volatility bounces tended to fare more poorly three days out than high volatility rises. While the numbers are too small for statistical significance, their bearish cast makes sense given that--thus far--the downside is attracting more interest than the upside and--in Market Profile terms--we are accepting value at progressively lower prices.

4 comments:

Michael said...

Brett, just an FYI. For those of us who read this blog in a newsreader (or at least on Bloglines) the yellow and purple(ish) text you sometimes use is almost impossible to read b/c it's on a white background.

Brett Steenbarger, Ph.D. said...

Thanks so much for bringing this oversight to my attention. I will correct the situation right away.

Brett

veterantrader said...

Your data somewhat confirms my belief that the market has been overbought for the 2 week bull run we've had for January 2006. The market had tremendous gains on the Fed announcing they may be finished with their tightening stance. Shortly after Intel, Citigroup and Yahoo were some that posted less desirable earnings implicating that much of the gains we've had in the past 2 weeks are not justified. The market thus corrected last week being down 4 days, with Friday being significant. Todays small bounce on low volatility does comfirm that many stocks are still overbought and the market is not expecting earnings to be spectacular, putting it I believe in a range in the weeks to come.

Brett Steenbarger, Ph.D. said...

Thanks for the note. I am closely watching the dollar and interest rates and may post something on the topic in the near future.

Brett