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.