Trading the Odds

A statistical approach to profit in the US equity markets, trading the markets like professional card counters are playing Blackjack or expert poker players are playing Poker.

Trading the Odds on Monday – April 20, 2009

On Friday the market traded in a very narrow range for a relatively quite session. Wilder’s True Range for the SPX came in at 1.71% which is the second lowest reading since 02/17/2009 (last 2 month). Breath was once again exceptional strong with NYSE Advancing Issues/Declining Issues at 2.07 and NYSE Advancing Volume/Declining Volume at 1.46. But again the SPX by contrast posted a ‘relatively small end-of-day gain’ of +0.50% (’only’). That is the second day in a row when NYSE breadth came in exceptional strong while the SPX by contrast posted a ‘relatively small end-of-day gain’.

On top of that Wilder’s Arms Index or TRIN ((Number of Advances / Number of Decliners) / (Advancing Volume / Declining Volume)) closed above 1.0 the second day in a row. An ARMS Index reading of one means that the market (supply and demand) is in balance, while a reading above one means more volume is moving into declining stocks (bearish) and vice versa. And last but not least the SPX underperformed the SPXEW (S&P EQUAL WEIGHT INDEX) by a wide margin of more than –0.80% the second day in a row, means the more capitalized stocks in the S&P 500 Index (regularly part of institutional portfolios) significantly underperformed the less capitalized stocks.

While Thursday’s setup (lopsided breadth session) with a negative forecast over the course of the next couple of sessions is still on board and will go into full effect from Monday – April 20 onward (NYSE Advancing Issues/Declining Issues ratio and the NYSE Advancing Volume/Declining Volume ratio both closed above 3.5, see my posting Follow-up on Trading the Odds on Friday – April 17, 2009), these setups and their respective historical probabilities and odds will add to the negative bias over the course of the next couple of sessions.

Since 01/03/2000 there were 33 occurrences when the SPX closed higher two consecutive days while the Arms Index closed above 1.0 on both sessions. The following table (Table I) shows the SPX‘ (S&P 500) behavior and the respective performance over the course of the then following 10 sessions concerning those 33 occurrences since 01/03/2000 which fulfilled the setup mentioned above (notable is the significantly below-average profit factor over the course of the at least following three sessions, see the last two columns):

survey-20090419-13

(click on image to enlarge)

Since 01/03/2000 there were 7 occurrences when the SPX closed higher three consecutive days while the SPX underperformed the SPXEW (S&P EQUAL WEIGHT INDEX) by a wide margin of more than –0.80% on the third day. The following table (Table II) shows the SPX‘ (S&P 500) behavior and the respective performance over the course of the then following 10 sessions concerning those 7 occurrences since 01/03/2000 which fulfilled the setup mentioned above, and table Table III shows the SPX‘ (S&P 500) behavior and the respective performance over the course of the then following 2 sessions including daily open, high, low.

Although the sample size with 7 occurrences only is too small to read anything into it, notable is the significantly below average win/loss ratio, the limited upside potential -not a single occurrence with a high +1.0% or more above the previous session’s close- and the below-average profit factor over the course of the at least following two sessions:

survey-20090419-21

(click on image to enlarge)

No. Date open high low close –
open
close
(next session)
2 session(s)
later
1 04/03/2009 -0,33% -0,33% -2,34% -0,51% -0,83% -3,20%
2 04/02/2009 +0,09% +0,97% -0,92% +0,88% +0,97% +0,13%
3 01/28/2009 -0,59% -0,59% -3,43% -2,73% -3,31% -5,52%
4 01/02/2009 -0,28% +0,52% -1,32% -0,19% -0,47% +0,31%
5 11/06/2002 -0,06% -0,06% -2,71% -2,22% -2,29% -3,14%
6 10/21/2002 -0,36% -0,36% -1,93% -0,70% -1,06% -0,40%
7 12/28/2000 -0,08% +0,44% -1,25% -0,97% -1,04% -3,82%

(’date’: date when the setup was triggered; ’open’, high’, ‘low’ and ‘close’: percentage change on the next session in comparison to the trigger date’s close; close – open’ speaks for itself: any positive percentage change means a close above the open and vice versa)

Bottom line:

  1. Thursday’s heavily lopsided breadth session (and by contrast relatively small end-of-day gain) does not only show a siginificantly above-average tendency for an at least limited upside potential over the course of the then following next couple of sessions, but regularly a tendency for lower quotes ahead. Probably a good time to take some money off the table. Not only the chances that the market will close lower over the next couple of session(s) are partly significantly above-average, even the odds (profit factor as the sum of all profits divided by the sum of all losses going long on close of the session when the setup was triggered, NOT the true chances that the event -a higher close x days later- will occur) are tilt in favor of a bearish outcome due to the fact that the respective profit factor over the course of the next couple of sessions is (significantly) worse than the respective at-any-time profit factor (see my posting Follow-up on Trading the Odds on Friday – April 17, 2009).
  2. Both setups triggered on Friday’s session (SPX underperforms SPXEW by a wide margin and Arms Index above 1.0 two running days while the SPX closed higher two consecutive days) add to the negative tendency not only due to the fact that the odds are significantly tilt in favor of a bearish outcome, but the true chances for a lower open/high/low/close as well.

And looking at historical probabilities concerning the SPX behavior over the course of the following two session after the Arms Index setup signal had been triggered in the past (they are all at least slightly worse than random/at-any-time, and even worse are the respective odds/profit factor):

  1. Since 01/03/2000, the SPX closed lower two days later on 23 out of those 33 occurrences for a probability of 69.70% versus an at-any-time probability of 49.98% for a lower close two sessions later.
  2. On 26 out of 33 occurrences did the SPX close lower over the next 2 sessions for a probability of 78.79% versus an at-any-time probability of 62.92% for a lower close over the course of any two session.

Successful trading,

Frank

P.s.: WordPress recently implemented a Twitter widget, so I’ll regularly make some intraday updates as well using Twitter (as I already did during the last couple of session, but unfortunately there seems to be a connectivity issue between WordPress and Twitter; hope that will be solved soon). If you’re interested in, please have a look at the blog during the trading session as well or subscribe directly to Twitter (recommended).

Disclosure: Long TYZ (Daily Technology Bear 3X Shares) at time of writing.

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3 Responses

  1. be the ball says:

    been following you for a week or so now. love the data. thanks for sharing it!

  2. Jimmy says:

    thanks for switching to the new table format, lot easier to comprehend. Keep up the great work.

    also, since most/all of us traders look at the chart pattern it’s quite obvious the SP500 is putting in a rising wedge pattern. another confirmation for, at minimum, short term weakness.

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