Thursday, March 23, 2006

Countertrend Equivalence: An Interesting Idea

I'm following up on the broad market's countertrend tendencies. When my trend measure registers that the market is trending over X time periods, it appears that the next X periods tend to reverse this trend. I need to research this further but, if true, this countertrend equivalence could be a solid basis for combining time frames in analysis. In other words, let's say you had a strong downtrend reading on an intraday basis *and* on a multiday basis. That should provide an excellent signal for a longer-term market purchase.

I went back to March, 2003 (N = 766) and examined five-day trend readings in SPY and then what happened in the *next* five days of SPY trading. When SPY displayed a strong five-day downtrend (N = 104), the next five days in SPY averaged a gain of .80% (68 up, 36 down). That is much stronger than the average five-day gain of .31% (448 up, 318 down) for the overall sample.

When SPY displayed a strong five-day uptrend (N = 196), the next five days in SPY averaged a gain of .17% (108 up, 88 down), weaker than the average five-day gain for the broad sample.

In short, five day trends are tending to reverse. The next question is: can we pair these five day periods with other time frames to create superior timing of trades?

No comments: