These numbers can tell you if the market will rally

One of the joys of market research--or any research for that matter--is the opportunity to discover new and interesting relationships. Many of these are random dead ends, but some open the door to new perspectives and understandings.

Right now, I'm not sure whether I have a dead end or a new perspective, so I'll let you decide. On my free research website, I recently looked at one-day declines and found that, since 2003, over 70% of all points gained in the S&P 500 Index occurred on a Monday or Tuesday. Interestingly, if you had only traded Wednesdays and Fridays over the past three years, you would barely be up money. Well over 90% of the recent bull market occurred on Monday, Tuesdays, and Thursdays.

As of Friday, we have been down over 1.5% in the past two days. To widen my investigation, I decided to look at the S&P 500 from 1995 through the present (N = 2792 trading days) and focus on two-day periods in which the market has dropped by one percent or more (N = 575). When the two-day decline fell on a Monday (N = 103) or Tuesday (N = 112), the change over the next two days averaged .38% (Monday: 60 up, 43 down; Tuesday: 58 up, 54 down). When the two-day decline fell on a Wednesday (N = 115) or Thursday (N = 126), the next two days averaged .03% and -.04%, respectively (Wednesday: 62 up, 53 down; Thursday: 64 up, 62 down). Fridays (N = 119) fell between these extremes, as the next two days averaged .22% (61 up, 58 down). What this suggests is that buying a two-day decline of one percent or greater was profitable on Mondays, Tuesdays, and Fridays, but not on Wednesdays or Thursdays.

Frankly, this made little sense to me. It is not clear why some days of the week should reverse weakness, but others shouldn't. To test the finding, I conducted the same analysis, but now focusing only on the most recent data from 2003 to the present (N = 774 trading days). In that time, we've had 105 two-day periods that have been down by one percent or more. Table 1 shows how the next two days shape up:

Table 1: Two-day price changes following two-day declines of 1% or more, as a function of day of week: 2003 - present

Now let's look at the completely independent data sample from 1995 - 2002 (N = 2018 trading days). Table 2 summarizes our findings:

Table 2: Two-day price changes following two-day declines of 1% or more, as a function of day of week: 1995 - 2002

What is clear from the division of the sample is that there is a similar pattern in the data over time. Two-day declines that fall on Monday, Tuesday, or Friday result in larger average changes than those falling on Wednesday or Thursday. Indeed, there seems to be no upside edge at all to buying weak markets on Wednesday or Thursday. This pattern has been surprisingly consistent for over a decade.

Random dead end or meaningful relationship? Only further explorations, which I will report here and on my site, will provide the answer. But if Monday is down, I may just consider buying...

Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com and a blog of market analytics at www.traderfeed.blogspot.com. He is currently writing a book on the topics of trader development and the enhancement of trader performance.