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In my recent article and on my free research blog, I found that strong concurrent performances by Google stock and the gold mining shares were associated with superior returns in the S&P 500 Index over the near term. I speculated that this might be because speculative sentiment was bullish on those occasions, carrying over to the broader market.
I decided to apply this reasoning to the small cap Russell 2000 Index (IWM | Quote | Chart | News | PowerRating), which has handily outperformed the large cap S&P Index (SPY | Quote | Chart | News | PowerRating) throughout the bull market. Most recently, the Russell has gained almost 3% in value over the past three trading sessions, making fresh bull market highs. The S&P 500, during that time, has gained less than 1%. My question was: Do big upward moves in the Russell lead to bullish short-term returns in the S&P?
Since January, 2003 (N = 768 trading days), I found 145 occasions in which the three-day price change in the Russell was greater than 2%. Over the following two days, the S&P was up by an average of .35% (96 up, 49 down). On all other occasions in the sample, the two-day change in the S&P was only .03% (313 up, 310 down). It thus appears that a strong Russell, like strong Google and gold, carries over to near-term strength in the S&P.
Another way to look at this is that, as long as market leaders keep leading, trends tend to continue. I strongly suspect that good short-term trend following strategies might be constructed simply by playing follow-the-leader.
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.
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