The Trading Digest

With the recent protracted slide in the financial sector many market observers have noted how this could be a sign of worse things to come for the limping market. In last weeks post I noted how a slide on the magnitude of 16% in the course of only 20 days pointed to a wild ride ahead.

The sector has slid more this week and I wanted to update the stats and present you with a trade that I think is setting up. We now have that same S&P Banking Index down 18% in 24 days as of the close on Wednesday. This has only happened on only 6 other occasions since 1983. Truly a noteworthy occurrence. As I reviewed the charts of the periods that triggered this condition I noticed that at times the SP-500 was in sync with the weakness in the Banking Index and at times only mildly so. One thing that generally happened fairly soon after this big drop in the Bank Index was a high volume reversal in the SP-500. I defined the high volume as the highest volume in the previous month and happening on a positive closing day.

If I were to test this condition (highest volume up day) on its own the resulting pop tends to be quite unimpressive but if this high volume pop up is preceded by the large banking drop the results are huge.

As I had mentioned an 18% drop in 24 days has only occurred on 6 separate dates that I have listed below.

The dates listed are the day after a close below the 18% level. If after this date we begin to look at the SP-500 chart and look for a reversal as defined by an up day on volume greater than all days in the previous month (21 days we’ll use) we would look to go long the next day at the market on the SP-500. We are going to look for a target in the 4-5% range.

Below you will find all of the charts of the SP-500 with the trigger date listed, the reversal day noted, and the profit target area were looking to hit. In each of these cases the target was hit very quickly even after entering after the large up move. The second entry date listed in 1998 actually happened while waiting for the earlier date to trigger a buy so we will only see 1 historical chart below for the 1998 entry.

This chart above of the 1998 entry shows our exit hitting in less than 2 weeks.

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Again the entry in 1999 above hits our target in only 11 trading days.

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The 2001 trade above hit out target in just over a week.

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In this the first of two 2002 entries our target is attained in only 2-3 days.

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In this second entry of 2002 we again hit our target area in just a few days.

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On average we see the large volume reversal entry day within 12 days after the large drop condition triggers. 1999 was the one that took much longer. All the others happened very quickly.

On average, our target area is hit in about 5-6 trading days. Think about that a 4-5% upside move in the SP-500 in 5 days.

Based upon this analysis I will be on the lookout for the high volume upward punch that will catch the shorts covering and those with limited equity exposure trying to catch the ride. As for me it is a trade. Nothing more. After my exit the markets can tank all they want. All I am doing here is trying to frame a trade. In terms of a stop - based on this historical snapshot I’d say a stop in the 7% area should allow enough room for the trade to work.

Keep your eyes peeled because if we get it. I won’t miss it.

Have a Great Weekend!

Dave Johnson

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