3 Consecutive Down Days on SPY

What is the 3 consecutive down days pattern? Just as the name describes, it’s simply a pattern in which we have 3 down days in a row. Each day, the close is lower than the previous day’s close. In other words, the trend for the last 3 days is down, and the sellers are probably in control for the short term. Below is an example of this pattern.

This pattern occurs somewhat frequently, and in all markets. Nevertheless, different markets have different tendencies. For markets that are more mean reverse, seeing this pattern could mean a buying opportunity. For markets that are more momentum driven, this could be a short selling opportunity.

It is a well-known fact that indexes are highly mean reversion market, especially the S&P 500 since it’s the most diversified index. As a result, after the S&P 500 makes a big move in one direction, it usually means reverse back to the average briefly. In addition, indexes have a strong tendency to go up over the long run, which can definitely help us with creating a strategy that only trade on the long side.

To find out if there is any edge to the 3 Consecutive Down Days pattern, I did a quantitative test to see what happened if I bought the close after 3 consecutive down days, then sell in X days after. The data is for ticker SPY from 1/1/2000 to 6/21/2022. Here are the results:

Notice that our exit signal is only for 3, 5, 10, 15, 20 days after which should give us enough varieties, and avoid overfitting. From this table, we can see that the win rate is around 60%, the average return is from 0.32% to 0.69%, and the median return is from 0.51% to 1.62%. All exits provided positive results. We can also see that the longer we hold, the returns seem to be better.

Now, let’s see what an equity curve for trading a strategy like this looks like.

For a simple exit, this equity curve is not bad! Of course, it’s not beating the buy and hold method. However, keep in mind that the draw down is a lot less and the percent of time in the market is also significant lower.

It’s clear that there is an edge for buying SPY after 3 consecutive down days. With a better exit & perhaps a profit target (hint), this strategy can be improved much further. However, that is beyond the scope of this blog. My goal is only to share ideas that have an edge, you will have to do your own research to improve upon these ideas.

Disclaimer: I am not a financial advisor. All information in this blog is for educational purposes only. 

Directional Bias Going into the Day When SPY Gaps Up 0.5% to 2%

In trading, gaps happen almost every day. Gaps indicate that something has changed overnight. The bigger the gap, the more significant it is. Some gaps allow us to have an educated guess on the direction of the day. In today’s blog, let’s look at what kind of information we can find from gaps.

Below is a table breaking down the gaps in SPY from -4% to 4% in 0.5% increment. The data is from January 2000 to February 2022. Notice that we have the number of occurrences, the average & median % change from the Open to Close, the total % change, and the % of times where we closed higher.

There are a few key takeaways from this table. First of all, nearly 72% of gaps are between -0.5% to 0.5%. Although if a gap is 0%, it’s not actually a gap but let’s just put it in this category for simplification. Furthermore, gaps that are more than 2% have a very small sample size, so no real conclusions can be draw from them.

When we gap down from -0.5% to -2%, we tend to continue going lower. The data shows that the average % change from the Open to Close for this kind of gaps is from -0.08% to -0.15%. Furthermore, the % of times where we closed lower is from 50% to 52.7%. Consider that the stock market has the tendency to go up overtime, this is a good information to keep in mind, but it’s probably not an edge by itself.

The real edge is when we gap up from 0.5% to 2%, we have a strong tendency to continue higher at a high frequency. The data shows that the average % change from Open to Close for this kind of gaps is from 0.04% to 0.81%. The median % change from Open to Close are 0.13% to 0.72%. In addition, we closed higher than the Open more than 58% of the times!! That’s pretty significant.

Below is the equity curve for a strategy of buying SPY every time it gaps up 0.5% – 2% and exit at the end of the day.

Notice that prior to 2010, this strategy didn’t perform very well. However, since 2010, this strategy has performed nicely in this bull market, and the equity curve is very smooth. This probably means that this tendency doesn’t really exist prior to 2010.

Here are the stats for buying gaps between 0.5% to 2% on SPY from 2010 forward. You can see that the average % gain and median % gain as well as the win rate increased significantly over this period.

On a final note, can this strategy be trade by itself? Maybe. However, that is not how I would use it. For me, it’s a good tendency to understand and use for day trading. Knowing that when SPY gaps up 0.5% to 2%, we tend to continue going higher very often; I can have a clear upward directional bias for the day. I can use this piece of information to structure my entries around the OPEN price. I can trade breakout more aggressive to the upside or buying pullback after the Open with much more confident. When SPY gaps up 0.5% to 2%, my focus will be mainly on going long instead of going short.

Disclaimer: I am not a financial advisor. All information in this blog is for educational purposes only.