Sunday, October 9, 2011

S&P 500 Biggest 3 day rallies - Bottom or bear market rallies trap ?

Last week we had a huge 3 day rally in S&P 500, where it bounced back from intra low of 1075 on Tue ,4 - Oct -2011) to close at 1165 on Thurs, 6 Oct 2011. That is a rally of +8.5% from intra day lows to close 3 days later.
And US S&P 500 was not alone, other major Stock Indices such as Australia S&P ASX 200 and Hong Kong `s Hang Seng  - both also had a similar rallies of +9%. ( Hang Seng closed at 17,707and ASX closed at 4162)
Now big questions are  - Is this the bottom ? Will the market test the lows again ? or are these just Bear market rallies ? To answer this questions, I have done a study and analyzed S&P 500 performance after such sharp 3 day rallies (during the bear market period).
Similar rallies were seen in Europe stocks - Germany - DAX up +10.4% to 5675 ,FTSE +8.6% to 5303.Also interestingly six countries were able to close above their 50 DMA`s - FTSE ,Germany DAX,France CAC,Spain IBEX,Italy MIB 40 and Australia ASX 200. See Global Macro Technicals post here for details. Commodites such as Oil,Copper also closed with gains of 5-6%

Here is the study.
  • Underlying - S&P 500
  • Period - (1) When S&P 500 is in bear market period. i.e below  200 DMA. This year in 2011, S&P 500 has been below 200 DMA since 1 Aug 2011. So period taken is 1 Aug 2011 to YTD Oct 2011.
  • (2) I have also taken the previous bear market period of 2008. S&P 500 closed below 200 DMA since 25 Dec 2007 till 25 May` 2009. The period I have taken is from 25 Dec 2007 to Feb 2009. ( as the bottom was made on Mar 2009).
  • I have taken a cut-off of + 5% or more , 3 day rallies. In 2011 bear market we have just 5 such instances. And in 2008 bear market, there are 25 such instances. So total cases of 30 since last two bear markets.
  • Lastly, I have then seen how does the S&P 500 perform , 7 ( Seven) trading days after the big 3 day rally.( 7 days after the close end of the rally.)
Findings
  • 80% of the time , the closing after 7 days was negative with Average and Median falls of - 3.1% and - 3.7%
  • Details in below tables (Click to zoom). 2nd table is sorted by highest rallies to lowest. This rally on 6 Oct 2011 ranks the 13th highest ever in both the 2008 and 2011 bear markets.
  • For S&P 500 - The average and median of these 3 day rolling rallies( in bear markets of 2008 and 2011 i.e total of 405 trading days) was +1.2% and +0.9%. This makes the recent 3 day +8.5% rally a 2 sigma event. ( FYI,a +15%  -3 day rally will make it a 3 Sigma event)
  • Max drawdown loss ranges from 0.1% to 4% with just 6 cases   / total of 30 cases ( i.e 20% of the time ) with average/Median loss of 2%. So 1-2% could be a good stop loss to avoid these low probability cases.

 And the last question that some of you might be having on your mind. How do you know if this is a bottom. ?
Going by performance in Mar 2009. We have 20% rally in just 12 trading days, from 10 Mar 2009 to 25 Mar 2009. And we have very frequent / back to back - 3 day rallies of over + 5% in 9 out of those 12 trading days. And even after 7 days of such 9 occasions, 91% of the time S&P 500 closed in positive vs the median /average of 80% of the time that it should have been negative.For other reversal confirmations, we can also see how the Dollar is performing, Euro Stocks are performing and Commodities such as Oil,Copper.
So let me know what you all think.

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