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 – June 8, 2009

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On Friday’s session we couldn’t have asked for more again. The market provided the favorable opportunity on the short side (see my post Trading the Odds on Friday – June 5, 2009) already before the open, and even the regular market open still presented the favorable (from a risk:reward perspective concerning the negative setup triggered on Thursday’s close) opportunity on the short side.

The ES (S&P 500 E-MINI) opened higher +1.06%, posted an intraday high +1.20% above Thursday’s close only to give back all of it’s gains and more to post an intraday low -0.80% below Thursday’s close, and finally closed unchanged on the day, confirming -from a historical perspective- the negative/weak tendency on the session after a negative setup (the S&P 500 closed higher at least +1.0%on the same day when ‘NYSE TRIN closed above 1.25 in negative territory‘) had been triggered on Thursday’s close .

Market breadth was relatively weak with NYSE Advancing Issues/Declining Issues at 0.95, and NYSE Advancing Volume/Declining Volume at 0.60 (NYSE TRIN at 1.57). Speculative interest was again running very high on Friday’s session, with the ratio of Nasdaq Total Volume / NYSE Total Volume at 1.85.

From my perspective one of the (if not the) most remarkable observations and setups triggered during (and especially on the end of) the last week was the fact that although the S&P 500 closed higher +2.23% on the week with 3 higher and 2 lower closes, all of the last 5 sessions closed with a NYSE TRIN (significantly) above 1.25 in regularly negative territory. The NYSE TRIN (or ARMS INdex) is defined as the ratio of [NYSE Advancing Issues/Declining Issues / NYSE Advancing Volume/Declining Volume]. With a ratio of 1 supply and demand are regarded as in balance, a ratio above 1 indicates that more volume is going into declining stocks (regularly corresponding to a lower close in the major market indexes), and a ratio below 1 indicates that more volume is going into advancing stocks (regularly corresponding to a higher close in the major market indexes). Any divergence may provide a favorable and tradable edge concerning the next session(s).

But although any short-term (1 or 2 sessions) negative divergence (advancing major market indexes with a NYSE TRIN in negative territory above 1) regularly provides a favorable trading edge and opportunity on the short side (as it was the fact on Friday’ session), such a persistant negative divergence might indicate something different concerning the S&P 500′ performance over the next couple of sessions (not looking on the next session only), especially due to the fact that the market obviously refuses to go down although the first impression would’ve been it ‘should’ after the negative setup (concerning the NYSE TRIN) had been triggered more than once during the last week.

I checked for the following setups which were all triggered at least once during the last week:

  • the S&P 500 closed higher on a day when the NYSE TRIN closed above 1.00 in negative territory (last Monday and Tuesday, Setup S1),
  • the S&P 500 closed higher on 2 consecutive sessions when the NYSE TRIN closed above 1.00 in negative territory on both sessions (last Tuesday, Setup S2),
  • the S&P 500 closed higher on at least 2 out of 3 sessions when the NYSE TRIN closed above 1.00 in negative territory on all three sessions (last Wednesday, Setup S3),
  • the S&P 500 closed higher on at least 3 out of 4 sessions when the NYSE TRIN closed above 1.00 in negative territory on all four sessions (last Thursday, Setup S4), and
  • the S&P 500 closed higher on at least 3 out of 5 sessions when the NYSE TRIN closed above 1.00 in negative territory on all five sessions (last Friday, Setup S5).

Table I shows the ES (S&P 500 E-MINI) performance (since 01/02/1990) on the next session immediately following those sessions where setups S1 to S5 listed above had been triggered.

20090605-ES-1

Not surprisingly -and as being a regular part of my daily posts- almost all (except setup S5) setups show a -regularly significant- negative tendency on the then following session, concerning both the probability for a lower close the next session as well as the respective odds (expectancy and pay-off) due to the fact that the average losing trade exceeds the average winning trade, and the maximum winning trade is significantly lower than the respective maximum losing trade.

Table II now shows the ES (S&P 500 E-MINI) performance (since 01/02/1990) over the course of the then following five sessions immediately following those sessions where setups S1 to S5 listed above had been triggered (the respective occurrences are listed in table III below).

20090605-ES-5Although sample sizes are getting way too small to read anything statistically relevant into it, it is nonetheless more than remarkable that that S&P 500 shows a significant positive tendency over the course of the then following week (5 sessions) on those setups where the negative divergence between  an up-trending stock market and a NYSE TRIN in negative territory above 1 persists for 3 sessions or more during a (rolling) 5 sessions time frame. Especially setup S5 which was triggered on Friday’s close (the S&P 500 closed higher on at least 3 out of 5 sessions when the NYSE TRIN closed above 1.00 in negative territory on all five sessions) shows an extraordinary positive tendency, with an average losing trade of -0.19% only (5 sessions later), and an average and maximum winning trade 5-fold as much as the respecitve average and maximum losing trade (therefore the outstanding profit factor of 16.72).

Lust but not least table III shows the ES (S&P 500 E-MINI) performance (since 01/02/1990) over the course of the then following five sessions immediately following those sessions where setup S5 had been triggered (as it was the fact on Friday’s close) , including a listing of all respective occurrences.

20090605-ES-2

Probabilities and odds as well are (sometimes significantly) tilt in favor of higher closes ahead, and downside potential was historically limited with a maximum drawdown of -2.48% (at the close) during the entire then following trading week.

Only in order to visualize how the S&P 500 performed during and after those times when setup S5 had been triggered in 2005 and 2006 (but not to be mistaken for cause and effect), please find attached below the respective chart. Coincidence or not, the market performed well at least over the course of the then following week(s).

StockCharts1(Chart courtesy of www.stockcharts.com)


________________________________

Bottom line:

  1. Although the sample size with 9 occurrences only since 02/01/1990 is way too small to read anything statisticall relevant into it, it is nonetheless remarkabel (to say the least) that the market historically shows a significant positive tendency over the course of the then follwoing 5 sessions after setup S5 (‘the S&P 500 closed higher on 3 out of 5 sessions when the NYSE TRIN closed above 1.00 in negative territory on all five sessions‘) had been triggered. So chances are good that the market will remain firm during the next week (as long as no other reliable setups will be triggered over the next couple of sessions), and probabilities are slightly tilt in favor of a higher close on Monday’s session as well. So -at least with respect to the persistent ‘NYSE TRIN divergence’ setup triggered on Friday’s close- any weakness at the beginning of next week may provide a favorable buying opportunity for the remainder of the next week.

Successful trading,

Frank

P.s.: WordPress recently implemented a Twitter widget, so I’ll regularly make some intraday updates as well using Twitter. If you’re interested in, please have a look at the blog during the trading session as well or subscribe directly to Twitter (recommended).

Disclaimer: No positions in the securities mentioned in this post at time of writing.

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2 Responses

  1. leon says:

    i made a comment based on your report the other day,(thursday) as to the day’s direction. and was quickly confronted. not wishing, to debate the merits , since in the end, no one really knows. i sent a copy of your report to the inquiring mind. the only reason i set this up is because. in today’s report you place heavy reliance on thennrgativentrin reading.

    i was reminded that some ” gurus” lbr, i believe carter and senters, were also mentioned, have backed away from the trin as a reliable indicator. i think more emphasis is being placed on the vix. (could be wrong in this). nonetheless, can you see any difference in the trin’s reliability in your research. excellent work by the way. makes a lot of sense to me. specially today . go figure.

    hope itally was ok.

    • Frank says:

      leon,

      in the end everything that works (giving you an edge) is fine (TRIN, VIX, astrology, rolling the dices, …), but backing away from the TRIN means you’re backing away from the balance between supply and demand which is -from my perspective and besides prices and time- (one of the) most reliable indicators you’ll ever get. On the other hand the VIX is an indicator of the market’s expectation of the next 30 calendar day’s SPX’ volatility, based on the implied volatility of a set of SPX options (a derivative of a derivative …). I’m a trader in VIX futures and options as well, but I’ve never found it especially reliable (e.g. based on divergences between SPX and VIX movements) in forecasting tomorrow’s major market indexes’ performance.

      But again: My analysis is regularly based on pure market data only (price and volume over time, at the most adding a simple mathematical formula like the TRIN or an SMA), and from my perspective utilizing indicators will bring you further away from the real pulse of the market, but if I’d hit on something (an indicator or anything else) which has a good/high quality of forecasting the next session(s) performance I woudn’t hesitate to take advantage of it. Trading the markets is not about being right or wrong but all about being profitable.

      Best,
      Frank

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  • w/ 18.30 at time of writing, the gap between $VIX and $VSTOXX is close to its all time closing low of 19.90, posted on 10/16/2008. 1 year ago
  • The $VIX gained 48.33% over the course of the last week. Since 1/2/1990 there were 38 other occurences w/ $VIX gained > 48% over 5 sessions. 1 year ago
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  • @QuantStratTradR Sorry, I didn't follow the entire communication. Link to what ? // @easyvolatility 1 year ago

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