One of my habits as I read around on the blogosphere is asking the question, “oh, really?” when I read certain assertions about technical indicators. Every so often, we find one that is applied to the S&P 500 index and is easily testable, and I positively salivate when that happens!
In this particular instance, it was pointed out on another blog that a week with (1) light volume, (2) a six-week high, and (3) a close below the open was an “undeniable short” setup. Hmm. While this intuitively seems like a signal of potential weakness, is it really a short signal? Going back to 1950 in the S&P 500, there are 149 instances of this situation, with 147 occurring far enough back in the past to test them. The most recent two were last week and two weeks back.
I tested the results for a short entering on the open on the following week, with alternate exits at the end of (1) one week, (2) two weeks, and (3) four weeks, for the weekly conditions (1) lighter than previous week’s volume, (2) a six-week high, and (3) a close below the open.
The average gain for the S&P 500 following the undeniable short setup was
One Week +0.319% with 62.6% positive
Two Week +0.198% with 56.5% positive
Four Week +0.616% with 61.2% positive
A short entry on the S&P 500 based solely on that setup would have given you a hygienic timepiece, i.e., you would have gotten your clock cleaned. But it’s not all bad. The average gain for the S&P 500 following the same entry/exits and a random signal was
One Week +0.349% with 65.5% positive
Two Week +0.647% with 66.9% positive
Four Week +1.252% with 70.3% positive
So apparently it is a sign of short-term weakness in the index, although it certainly is NOT a reliable short signal. With only 147 testable instances over 57 years of data, I wouldn’t feel comfortable trying to narrow it down to specific market periods or types of markets. For example, we’ve had seven such instances in this one rally from the May 2006 correction, five of which were testable, but we’ve only had fourteen such instances in the bull market of the last four years.
The motto: test what you read.
2 Comments
Bill,
Perhaps you mentioned this before and i’ve missed it, but how do you go about your testing–excel, wealthlab, etc?
best,
James
I usually test ideas like this in Excel.