The inside scoop
07/27/18
On a day dominated by tech news (see “Market Mover Update,” below), the S&P 500 (SPX) had a pretty quiet Thursday, as shown in the daily chart below. With a couple of hours left in the trading session, the large-cap index was down a bit from the previous day’s close, but was still trading within Wednesday’s high-low range—an “inside day.”
S&P 500 (SPX), 6/01/18 – 7/26/18. S&P 500 (SPX) price chart. Inside day pattern. Lower high, higher low.

Source: OptionsHouse

Yesterday’s relatively subdued SPX price action may have been the product of a few factors: The market could have been a little “tired” after the previous day’s rally, tech was weighing on the broader market, and there was a big number due out today (GDP report). Hence, a “wait-and-see” type of trading session.

The common wisdom regarding inside days is that they represent a market hitting the “pause” button: Prices were unable to push beyond the previous day’s range, so they don’t really factor into analysis—whatever market outlook prevailed before the inside day should be assumed to be still intact. So, if the market was rallying before the inside day, we should expect it continue to after it.

That’s a broad statement, though. Let’s look at something more specific: the performance of the SPX after two variations of inside days similar to yesterday’s:

1. An inside day that closes above the open, where the previous day is at least a 10-day high (and high close).

2. An inside day that closes below the open, where the previous day is at least a 10-day high (and high close).

Since July 1997 there have been 49 of the first type and 90 of the second type. Here’s what the SPX did the day after them:

1. Median return: -0.3%; percentage of times SPX closed higher: 49%.

2. Median return: +0.05%; percentage of times SPX closed higher: 52%.1

In other words, whether the inside day’s close is above or below the open may offer some indication of whether the next day is more likely to close higher or lower—but it’s also counterintuitive: An inside day with a close above the open was more likely to be followed by a down day, and vice versa.

Useful information? Maybe. But there’s something that those stats don’t tell you: The SPX’s most recent upswing is an extension of the breakout move above the March high, which was the index’s final technical barrier before a possible challenge to its all-time high above 2872 (see “Stocks hold ground amid geopolitical drama”). As of yesterday, the index was just a little more than 1% from that threshold. If you don’t think traders (and investors…and the financial media) aren’t considering the positive sentiment that might accompany such an event, well…

S&P 500 (SPX), 12/15/17 – 7/26/18. S&P 500 (SPX) price chart. All-time high. Nearby milestones

Source: OptionsHouse

There was also a political development from late Wednesday that got submerged in the Facebook story: The apparent easing of trade tensions between the US and the European Union, the announcement of which coincided with a strong rally at the end of Wednesday’s trading session.1

So by all means, traders should take into account the historical performance after certain price patterns, but the analysis doesn’t have to stop there. No one should ignore cold, hard data, but numbers don’t always tell the entire story.

Market Mover Update: To say that Facebook’s (FB) correction yesterday made headlines is an understatement. It’s impossible to know whether the bottom is in, or more selling is to come, but speculation regarding the future of Facebook, and about market “panics” in general, brings to mind the words of one of the original sages of Wall Street, financier and author Henry Clews, who wrote the following in 1888 (that’s not a typo):

“[Old] veterans of the Street usually spend long intervals of repose at their comfortable homes, and in times of panic, which recur sometimes oftener than once a year, these old fellows will be seen in Wall Street, hobbling down on their canes to their brokers’ offices.

“Then they always buy good stocks to the extent of their bank balances[.]”2

Something to think about in times of hyperbole.

 

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Supporting document available upon request.

2 CNN.com. Trump and top European leader agree to work toward zero tariffs. 7/26/18.

3 The Cosmopolitan, Volume 5. How to Make Money in Wall Street. March-October 1888.