Sunday, January 11, 2009

Stock Market Trends Are Still Not Quite Your Friends

I decided to take a fresh look at an old market pattern and see how the S&P 500 Index (SPY) has behaved since the start of 2007 under two conditions:

* When it is up both on a one-day and a five-day basis

* When it is down both on a one-day and a five-day basis

When the market has been up yesterday and over the past week (N = 163 trading days), the next five days in SPY have averaged a loss of -.97% (66 up, 97 down).

Conversely, when the market has been down yesterday and down over the past week (N = 155), the next five days in SPY have averaged a gain of .20% (86 up, 69 down).

What seems to be happening is that markets that are up or down most recently and over the last few days have short-term and swing traders leaning the wrong way. When they unwind their bets to protect their capital, they contribute to countertrend moves.

In the past, I've written about how to lose money in the stock market, including how to lose by buying into uptrends. Those lessons seem relevant in the current environment: it's when stocks look obviously strong or weak that markets are most likely to confound human nature and we are most likely to see countertrend behavior.
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