After Two Consecutive Strong Days, What's Next?

 |  Includes: DIA, QQQ, SPY
by: Brett Steenbarger

We've seen two consecutive days in which the S&P 500 Index (NYSEARCA:SPY) has shown strong gains, hitting the R3 upside target on each of those occasions. (Note: R1/R2/R3 and S1/S2/S3 are proprietary pivot-derived profit targets that are adjusted for market volatility; they are published prior to the market open each day via Twitter). What has happened historically following two days of such strength?

Before I deliver the punch line, let me emphasize that the market has indeed shown strength lately. Monday saw us take out the early May high in the advance-decline line specific to NYSE common stocks. We also saw 59% of S&P 500 issues close above their 200-day moving averages, a high for this bull move. Finally, we registered over 2300 65-day highs among NYSE, NASDAQ, and ASE stocks, well above the 2003 achieved on May 6th.

Going back to 2000, when we've had two consecutive days that have touched R3, the next three days in SPY have averaged a loss of -.23% (74 up, 82 down); the remainder of the sample has averaged a three-day loss of -.02% (1161 up, 1034 down). While that is not a huge bearish bias, it does tell us that it is not uncommon for two consecutive days of strength to see some profit taking over the next few days. Interestingly, there is no bearish bias for the next day of trade, which averages a loss of -.10% (85 up, 71 down).

In short, while we have signs of significant upside strength, some consolidation of this strength during the week would not be unusual. If the breakout from the May trading range is to be sustained, we need to stay above the early May highs of 93.22 in SPY from May 8th. In other words, any consolidation from here should be relatively modest if we are seeing the start of a fresh bull leg.