LunaticTrader

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Posts Tagged ‘1% down days’

We got a 1% down day, what next?

Posted by Danny on March 22, 2017

The S&P 500 dropped 1.2% yesterday and this ends a 109 day streak without 1% drop. This is only the 13th such +100 day period since 1950 for the S&P, see my February post.
This drop was met with panicked reactions and crash warnings on social media, but people forget that 1% down days in the S&P 500 are nothing special. Over the last 67 years the S&P 500 has had 1662 such down days, or 10% of the time. That’s about one 1% down day every two weeks on average. But traders have very short memories and when something hasn’t happened for 5 months it feels as something special already.
The previous 1% down day was 11 October 2016, do you remember it? Probably not.

What’s more interesting is what happens after such a long streak ends. Here is the updated list of +90 day periods:

1pc_down2

While most investors intuitively think that a first big down day after a long absence of such days is a bearish sign and maybe the start of a crash, history shows us otherwise. More often than not the market just keeps climbing after that first big down day. Two weeks later (10 trading days) stocks were higher 8 times out of 13. After two months (40 days) the market was higher 11/13 for an average gain of 3% ( = 19% annualized). And a year later the S&P 500 was higher 11/13 for an average gain of 14.8%.
While this doesn’t guarantee similar gains in the coming months, there is certainly no reason to believe that yesterday’s 1% down day is a very bearish omen. If anything you should probably use this drop to pick up some cheap long term call options in the coming days. That’s the counterintuitive thing to do here.

Sure, this drop does some technical damage and has probably shocked a few investors. A trend line is clearly broken and now the market will search for a bottom from which it can start to rally again. How long that healing will take is a guess at this point. I like to keep an eye on my aggregate stats for bullish and bearish stocks in S&P 500. This is what we have at the moment:

spx

The number of S&P stocks in bullish mode (red line) has dropped to 230, which is below 50% for the first time since early November. Stats have been weakening slowly since early March, very similar to what happened in Jul-Aug 2016. When the red line bottoms out it will be a first positive development and when it gets back above the blue line we can start thinking about a new sustained rally.
I wouldn’t be surprised to see the market test the bottom orange trend line in the coming week or so. And that’s where it will get interesting.
Patience pays.

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A long absence of 1% down days

Posted by Danny on February 24, 2017

The S&P 500 hasn’t had a 1% down day (on a closing basis) since 11 October 2016. That’s 92 trading days without a more than 1% decline, the longest such streak since late 2006. If the market keeps this up a few weeks more then the current series will join the 100+ day club, which would be the first since 1995.

Investors generally don’t care about days when the market goes down 0.4%, 0.7%,… But when benchmark indexes are down more than 1% in a single day then it stings. Since 1950 there have been only 12 occasions when the S&P 500 went more than 100 trading days without a 1% decline. I wanted to see how the market performs in the weeks and months after such a long streak ends. Here is the list including the 2006 streak, which ended at 94 days:

1pc_down

The table shows the ending dates and how many trading days the S&P had gone without a 1% drop. The longest such period was 154 days, which happened twice. The next columns are more important, showing the market performance in the 10 days, 40 days and 250 days after a long period without 1% down days ends. This is trading days, so roughly corresponds to 2 weeks, 2 months and 1 year after the 1% down day that ends a streak.

On average the S&P climbed 0.77% in the next 10 days, 3% in the next 40 days and 14.8% in the next 250 days (= 1 calendar year). To put that into perspective, since 1950 the average performance has been 0.33% in 10 days, 1.3% in 40 days and 8.7% in 250 days.
Somewhat surprisingly we see that the market has performed much better than average after a 1% down day that ends a +100 day streak. Intuitively one would think that the first serious down day after a long period of relatively “painless” trading would often start a more serious downturn. But that happened only once, in 1957 when the S&P dropped more than 10% in the next 40 days. Most of the time that 1% down day was a great buying opportunity for the short and medium term.
The reason seems to be that such 100 day series tend to happen in the midst of multi-year stock price advances and not towards the end of them. So, when that first 1% down day finally comes there are usually several months if not years left in the ongoing bull market.

The problem with this kind of studies is that it suffers from the “law of small numbers”. We have only 12 historic cases, so we cannot be very confident the same will happen again. Here is the list of streaks that were 50 to 90 days long:

1pc_down2

Obviously those shorter streaks without 1% down days have been more common, but the subsequent market performance shows a totally different picture. Now we get a -0.4% in the next 10 days, -0.5% in the next 40 days and an average gain of 4.7% in the next 250 trading days. This is significantly worse than the average over this test period.

The current dearth of 1% down days will end sooner or later. But will it be a buying opportunity or not? On the basis of the history of 100 day streaks we would say yes, but the second table of 50-90 day streaks suggests that our 100 day club may have been very lucky. It is a good example that shows us how careful we should be with anything that has been observed only ten or twenty times.

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