We have been talking on the desk about the daily range in the S&P futures tightening over the past few days. Put another way, there have been short doji candles on the daily chart of the Spooz for the last several days:
What tends to occur when we see a tightening of the daily range for several consecutive days? In attempting to analyze this type of behavior in the market, I defined tightening of the daily range as days when the range ended up being less than the 20 day average daily range (ADR). For instance, today the market traded in an 11.5 handle range when the 20d ADR has been about 17.75 handles. So today’s action is considered to be a tightening of the daily range by my definition. Similarly, yesterday the market traded in a 12 handle range whereas the 20d ADR had been about 18.25 handles. Hence, yesterday also showed a tightening in the daily range.
What I am interested in here is consecutive days of tightening in the daily range. Again, using my definition, today marked the fifth consecutive day of a tightening in the daily range. My data goes back to January 2000 so since then there have been 230 instances when the daily range tightened five sessions in a row. This number translates to the market having demonstrated this type of daily range tightening just 8% of the time since the year 2000. Clearly, it does not occur frequently.
In my analysis I chose to see where the market ends up closing in the subsequent five and ten days. Here are the data results:
The yellow cells denote input fields.
“Next Time Period Pct Chg Input”: Instances when the 5d and 10d returns are more than x number of basis points
“Upside: Next Time Period Pct Chg Input”: Instances when the 5d and 10d returns are more than x number of basis points
“Downside: Next Time Period Pct Chg Input”: Instances when the 5d and 10d returns are less than x number of basis points
The rest of the fields should be pretty self explanatory.
I chose to use just the next 5d and 10d returns as I do not want to look that far out in time. I believe that consecutive days of tightening in the daily range will yield more substantial market moves in the short term. In other words, we will break out of the tight range as the market more decisively picks a direction. Going right into the probability outputs above, the data suggests that the probability of >0%, or moving higher, in the next 5 and 10 days are 59.1% and 57.4%, respectively. Those odds definitely do not give me conviction to either side. To obtain a clearer picture of the degree of the moves over the 5d and 10d period, I included two other input fields to help gauge upside potential and downside risk. I chose the upside inputs as percentages over 1%, which is simply the number that I feel qualifies as a solid move higher (and also a good psychological level, in my opinion). The way to read these last two probability measures is as follows: if the market is up in the next five days, then the probability of the rally being more than 1% is 62.5%; if the market is down in the next five days, then the probability of the sell off being more than 1% is 67.0%. On the other hand, if the market is up in the next ten days, then the probability of the rally being more than 1.5% is 50.7%; if the market is down in the next ten days, then the probability of the sell being more than 1.5% is 70.21%. (I upped the percentage for the 10d time frame as I would expect the market to move more over the course of 10 days as opposed to just 5 days.)
This data is only mildly bullish, if that, since the odds do favor an up more than 0% over the next five and ten days. Again though, these odds are still very weak (I might even argue that the odds are still about 50/50 to the up or down side). Also note the average returns: the average 5d chg is 0.03% and the average 10d chg is -0.33%. However, the median chg’s of 0.47% and 0.31% suggests that the averages are pulled lower by larger sell offs. In fact, the one worrisome piece of data in my analysis is that for the 10d time period, the odds of selling off more than 1.5% if we do get a pull back are 70.2%, which is a fairly high number. Meanwhile, the odds of us rallying more than 1.5% if we do get any rally are just 50.7%. This data reads to me that the downside risk is greater than the upside potential. Having said that, if I see any sign of weakness in the market, I would be quick to sell in order to hedge against this risk.
Overall, I don’t see an extended tightening of the range as an indicator for anything huge. The odds are too close to the 50/50 mark for me to feel any conviction to one side. Any suggestions on ways to analyze this data would be welcomed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.