At this writing, the market has enjoyed a nice 4% gain in over 6 trading days. It’s even more if you track it from the low to the high. From trough to peak the S&P 500 moved about 5.59% – nearly a 1% move daily!
Now with the power of AI chatbots and some Excel knowledge, that made me wonder, what typically happens during the next 5-7 days after a big move? Does the market keep moving in the same direction? Or is it time for a reversal?
Using data from Yahoo Finance for the ticker, SPY, I downloaded as much as I could – back to about 1996. I looked for an initial >4% move in 7 days or less.
There were 135 times this happened, out of 8,052 days of data, or roughly 1.5% of the time. That means we’re in a pretty rare situation.
I was looking for anything more than 4%, but it turned out the average of any move greater than 4% in 7 days during the 135 times this happened was 5.10%.
The next 7 trading days on average resulted in a net gain of 0.08%.
Well, that was a dud. Is that right? Nothing happens?
All of that work only to tell me the markets don’t do anything? I suppose that does tell us something. Maybe a neutral strategy?
We have some outliers to contend with – those black swan events that we don’t want to acknowledge. For example, let’s revisit 2008 for a moment. There was the 7-day period that ended on October 20th that gave us an impressive 11% gain. What happened after that? The next 7 days it dropped more than 6%.
Those events will happen, but let’s remove the outliers from the data and see how the distribution looks to see if we can get a clearer picture of a likely outcome.
This shows the gain or loss over the next 7 days after rising by more than 4% in the previous 7 days or less. It also shows the number of times, or density, of a similar move and compares that with a normal distribution curve.
We have more instances of the market rising over the next 7-day period (higher density above 0), with it not likely to go up more than about 2.5%. The likelihood of a trend continuing is greater than the normal bell curve for the data.
While the average move is near 0, that’s because there are some big numbers, like a -5% move that pull the average lower, but there are more times when the market makes an increase of 1-3%.
But, as much as everything is positive and seems impossible to go down, remember that the market is mean-reverting, which means the market will come down at some point. As much as the data shows a higher density for an upward move, remember to look at the left side of the chart. Even after removing the outliers, there are some cases of the market falling by over 5% in 7 days even after rising by more than 4% in the previous 7 days. That is showing you the concept of mean reversion right there.
Ok, ok. Too much data. What to do?
Just remember, what comes up must come down (and mean revert).
Have a great weekend!
