Redefining the Market Game

A few market observations:

*  Going back to 2006, if you bought SPY when fewer than 50% of SPX stocks were trading above their five-day moving averages, the next five trading days averaged a gain of .44%.  If you bought SPY when more than 50% of SPX stocks were above their 5DMA, the next five trading sessions averaged a loss of -.08%.

*  If you divide market days since 2012 into quartiles based on the aggregate put/call ratios of individual equities, the top two (highest) quartiles average next five day gains in SPY of .90% and .40%.  The bottom two (lowest) quartiles have been essentially flat on a next five-day basis.

*  If you bought SPY after the highest quartile of VIX days since 2012, your next five-day gain averaged +.82%.  If you bought SPY after the lowest quartile of VIX days since 2012, your next five-day loss averaged -.18%.

*  If you bought SPY after the highest quartile of five-day volatility periods since 2012, your next five-day gain averaged .79%.  If you bought after the lowest quartile, your next five-day loss averaged -.06%.

What might account for these observations?

*  One hypothesis is that a significant proportion of market participants are over-leveraged.  This means that they formulate trade ideas on a longer time scale but have to manage risk on a shorter horizon.  The inability of market participants to take heat that is normal for a market's present level of volatility sets up short-term trading opportunities in which overstretched long and short positions need to be unwound.

Implications:

*  On the short time horizon, what matters most is not so much macroeconomic relationships or chart patterns, but the behavioral tendencies of other market participants.  A great deal of the skill of reading markets consists of reading other traders.

Further Reading:  A Remarkably Consistent Trading System
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