Tuesday, November 8, 2016

Yesterday's Big Gap-Up Was Worth Noting

After falling for nine consecutive sessions, the S&P 500 put an emphatic end to that streak yesterday by gaining 2.2%.  The rally was sparked on Sunday evening in the futures market after FBI Director James Comey told lawmakers that, after a review of new emails, Hillary Clinton should not face criminal charges.  The market celebrated the news and by Monday morning, the S&P was set to gap higher by nearly 1.5%.

Given the nine day losing skid, the market went into last weekend approaching some fairly notable oversold levels.  And while a near-term bounce could have been expected, it's unlikely that too many of us were predicting the huge bounce we saw on Monday.

The recent market action nudged us to go in search of prior instances where we saw big gap-up openings in the SPY after reaching oversold levels.  One study we ran looked for gap-ups of at least 1% while the 14-day RSI on the SPY was in oversold territory (< 30) at the close of the prior trading day.

Observations (going back to SPY inception in 1993):
  • Returns going out 3-months after a signal are incredibly favorable.  This trade offers an "edge"
  • Yesterday was only the 19th occurrence since 1993.  We anticipated more.
  • Almost all of these instances occurred during periods with elevated volatility
  • Rarely did it mark the final bottom for the market during that particular period
  • However, we did note that a tradable bottom wasn't far off in many cases
  • Yesterday's signal was the first ever to occur within 5% of all-time highs (Friday's close at 2,085 is 4.95% from the all-time high of 2,193)

Below are some of the periods shown above:






Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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