Monday, December 18, 2006

Is A Trending Bull Market Due For A Fall?

Over the past five months, the major stock market indices have been in a steady uptrend. How have similar uptrending periods resolved themselves? Do we get further strength, or do we see evidence of reversal?

I went back to June, 1989 (N = 4326 trading days) and found 337 periods in which the S&P 500 Index was similar to today's market: up by more than 10% over a 100-day period; up by over 5% over the last 50 days; and up by more than 2.5% in the past 25 days, with the gains over 100 days exceeding those of 50 days and those of 50 days exceeding those of 25 days. These have been steady uptrend occasions.

Twenty five days later, the S&P 500 Index was up by an average of only .16% (200 up, 137 down). That is weaker than the average 25-day gain of .90% (2609 up, 1717 down) for the entire sample. When we look 100 days out, however, the average gain following the uptrending period has been an impressive 6.00% (276 up, 61 down). That is stronger than the average 100-day gain of 3.60% (3030 up, 1296 down) for the entire sample.

What we're seeing, of course, is that the market has been highly bullish since 1989--some decent bear moves notwithstanding. After we've already had a trending up move for 100 days, returns have been subnormal over the next 25 days, but have actually been quite healthy over the next 100 days. The reversal effects that we've seen in short-term market movements have not occurred when we look as far out as 100 days.

This has implications for investment--as opposed to active trading--strategies and for traders interested in diversifying their returns by holding over a variety of time frames. About 80% of all uptrending 100-day periods since 1989 have been higher 100 days later. Interestingly, however, seven of the last ten occasions--those since December, 2003--have lost money. Even at the longer time frame, the most recent market regime has not rewarded trend followers.

8 comments:

Anonymous said...

What a great pattern!

--h

Brett Steenbarger, Ph.D. said...

Yes, indeed; thanks. I ran several variations of the pattern to simulate a relatively straight line advance and each time the next 100 days looked quite favorable on balance.

Brett

NO DooDahs said...

No surprise. Trending over long horizons and mean-reverting over shorter horizons.

Brett Steenbarger, Ph.D. said...

Yes, that forms the basis for some interesting trading strategies across different time frames. Thanks--

Brett

NO DooDahs said...

Like "buy on the dips" LOL

Brett Steenbarger, Ph.D. said...

That's right, and yet I'm also seeing different performance re: buying dips for different ETFs, per my 12/20/06 post. Very interesting to see different regimes in different trading instruments. Thanks for your interest--

Brett

NO DooDahs said...

Yes. Stocks are more subject to trend than the stock indices, some commodities are trendier than others, some commodities respond best to counter-trend techniques, it really points out that you have to know your instrument to have an edge.

This, of course, in addition to picking the proper instrument to trade the underlying. I'm working on some research there ...

Brett Steenbarger, Ph.D. said...

Hi NO DooDahs,

Very well stated; thanks. Best of luck with your research. I'm finding very interesting differences in trading patterns among sector and index ETFs.

Brett