Monday, October 16, 2006

The Market's Patterns Are Not Our Own

All traders pay attention to price change, but should they also be looking at the patterning of that change? Does *how* a market moves from one point to another make a difference in its future movement?

In my recent post, I looked at strong 60-day periods in the market and showed how it is not just the trend of price change, but its trajectory, that leads for those moves to persist. This post will focus on short-term moves of five days going back to 2004 (N = 697 trading days).

During that time, we've had 258 occasions in which the S&P 500 Index (SPY) has been up over the last five sessions and up over the most recent session. Three days later, SPY has averaged a loss of -.03% (130 up, 128 down). That is weaker than the average gain of .09% (387 up, 310 down) for the entire sample.

When the previous five sessions have been up, but the most recent trading day has been down (N = 133), the next three days in SPY average a gain of .04% (74 up, 59 down)--a bit weaker than average, but not so weak as the dual up periods.

When the previous five sessions in SPY have been down, but the latest day has been up (N = 119), the next three days in SPY have averaged a gain of .15% (68 up, 51 down), somewhat better than average.

When the last five sessions are down *and* the most recent trading day is down (N = 187), the next three days in SPY average a gain of .25% (115 up, 72 down), handsomely above average.

These data fit nicely with the findings of Larry Connors and Conor Sen in their book "How Markets Really Work", which found that returns are better after short-term weakness rather than short-term strength.

The results also suggest that market returns are patterned in a manner that is precisely the opposite from the pattern of human expectations. If we see something rise during the past day and also during the past five days, it is human nature to look for the trend to be our friend and continue into the next several days. Conversely, if the market is down today and has been down over the past week, we naturally consider the market weak and expect further price softness.

But what happens is precisely the opposite.

The psychology of short-term trading begins with the simple realization that the market's patterns run counter to the cognitive and emotional patterns of the average person. Which may be why average people do not profit as short-term traders.


WilyTrader said...


Excellent video on, thanks! I really took your take on Transitional Structures to heart and have begun incorporating Market Delta info into my approach. I'll be posting updates on my blog, but I can notice a difference already in my results (well, after a rough start this morning anyway).

So thanks and keep up the excellent work!

~ WilyTrader
Dream, Trade, Grow

Sabretache said...


That chimes closely with my personal experience.

I'm in my 4th year trading my own accounts full time. It took a full 2 to become consistently profitable with intra-day and short-term swing trading. Using a number of good tools, my intra-day modus operandi was (and largely remains) to watch price volume action closely on 3-5 minute charts and various sized tick charts dependant upon session time and instrument, against a host of S/R, retrace/extension, pivots, trend lines, spreads etc - all auto-updated real-time. During my second year I logged every trade in terms of the number of ticks the mid-price moved against me before being either stopped or moving into profit. It turned out that over 90% showed a near immediate adverse excursion of 5 ticks or more!!! My response?

To endeavour to maintain the exact same objective entry/exit criteria but to trade in the opposite direction to that indicated and to take profit after 4-5 ticks. Sounds simple but in fact it is damned difficult to do. All my perceptions are screaming 'it's a buy (or sell)' but I have to push the button in the opposite direction. Turns out to be consistently profitable though.

BTW, I'm impressed with the statistical information you post. Can I ask what tools you use?

Brett Steenbarger, Ph.D. said...

Thanks, Wily, for the feedback; I look forward to tracking your progress on your blog. This AM was a bit tricky. What I find, most of the time, is that when there's selling in the ES (seen in Market Delta), but the TICK is persistently positive, the market's direction generally resolves in the direction of the TICK.


Brett Steenbarger, Ph.D. said...

That's a great example of training yourself to think like the market, Sabretache. Thanks for the note. My stat analyses are actually quite simple and use data from my real time feeds (RealTick and e-Signal) along with some archived data, with analyses via the database functions w/in Excel.