Thursday, May 18, 2006

What the Relative Range is Telling Us About This Decline

Recall that the relative range is a measure that compares the range of the last day or week with the median range for the past 20 days or weeks. The logic behind this is that people's psychological responses are to relative events, not absolute ones. They will, for instance, react differently to a 40 degree afternoon in summer than to a 40 degree day in mid January.

Yesterday, we had dropped 4.3% on SPY for the past five trading sessions. The five-day relative range was 2.39, which means that the range was more than twice the median five-day range for the past twenty days.

Since March, 1996 (N = 2551), when SPY has been down 4% or more for a five-day period (N = 120), the next five days in SPY have averaged a gain of 1.03% (75 up, 45 down). When we look at occasions when SPY was down more than 4% *and* the relative range was twice or more its median (N = 36), the next five days in SPY averaged a gain of 2.31% (25 up, 11 down). Conversely, when SPY was down more than 4% and the relative range was less than twice its median (N = 84), the next five days in SPY averaged a gain of only .48% (50 up, 34 down).

What this suggests is that periods such as the current one, in which a steep drop is accompanied by a sizable expansion in the relative range, yields superior returns in the near term. Perhaps this is because the large drop on a large range represents panic selling of short-term traders, creating value for longer timeframe market participants.


Steve said...

I like the idea of determining relative range in order to help predict potential persistency of trends/trades.

Previous posts of yours have forced me to think 'perhaps my method is fine- but I'm in the wrong vehicle for the current market conditions. Maybe I don’t need a trading coach… Just a better vehicle for right now'

Sure enough, now that the logjam in the indices has broken and the VIX is up, my P&L has rebounded nicely trading my standyby, the YM. My method's trades are following through, and I'm not getting chopped to death like I was previously.

My question... Since all trading vehicles ebb and flow and are hot at times and ice cold at others, other than the VIX, what indicator or study might I use to help quantify the potential for persistency of trades?

Momentum, ATR, ADX and the like haven't worked the way I'd hoped. Perhaps I’m using them incorrectly, but I haven’t found my ‘NOW is the time to work with this vehicle, rather than your usual one, until persistency returns.’

My goal is to determine when to ignore my main vehicle (the mini indices) and focus on perhaps another mini (oil, gold, silver, whatever) when they are particularly hot...


Brett Steenbarger, Ph.D. said...

Hi Steve,

Thanks for your note. I would say that comparing markets for trending behavior and volatility would provide the best way of identifying promising vehicles for trading. Screening tools for individual stocks can help you find vehicles within the equity world.