Traders get used to hearing things like “This is a make-or-break level for the market,” even though few levels are truly make or break, and those that are can only be identified after the fact. But by having an understanding of what a market is likely to do at a certain juncture, you can better prepare a game plan—regardless of which way it ends up going. The S&P 500 (SPX) this week offers a good illustration.
Other than Tuesday’s sell-off, last week’s SPX price action might have seemed rather unremarkable. After that big down day, the index rebounded to close out the week toward the top of its range—pretty much where it opened the week and almost exactly where it closed out the week before that (see weekly chart, below).
But that weekly bar may offer some insight into the market’s possible near-term trajectory. Last week had a couple of unique characteristics—the combination of trading a good deal (1.8%) below the previous week’s low, while both opening and closing relatively high within the week’s range (the top 20%). Does that price action “mean” anything—that is, does the market’s ability to rebound off a lower low and close strongly increase the likelihood it will trade a certain way going forward?
Rather than just eyeball charts and look for similar weeks, we can use a few simple rules to objectively define last week’s SPX bar, find past examples that match it, and see if there is any consistency to the way the S&P performs after them. For example, we could find all weeks that:
- Have a low at least 1.75% below the previous week’s low.
- Open and close in the top 20% of the week’s range.
The problem is, there have been only 12 other weeks like that in the S&P since 1960—not enough to draw any reliable conclusions about any tendencies we might see. So let’s loosen up things a bit and look for weekly bars that:
- Have a low at least 1% below the previous week’s low.
- Open and close in the top 30% of the week’s range.
This should provide a few more examples to look at, but still keep things focused on the type of price action we’re interested in.
This time we end up with 74 such weeks since 1960 (the two most recent were February 12 and January 22, 2016), and the SPX exhibited some pretty consistent behavior after them. One week later the S&P:
- Closed higher 59% of the time (vs. 55% for all other weeks).
- Posted a median gain of 0.69% (vs. 0.26% for all other weeks).
In other words, the SPX closed higher more often—and typically had a larger gain—than it did compared to other weeks since 1960. This bullishness also played out at the two-week mark:
- The SPX closed higher 62% of the time (vs. 57% for all other two-week periods).
- The SPX posted a median gain of 1.47% (vs. 0.51% for all other two-week periods).
So, everything else being equal (always a big “if” in the markets), there’s at least a logical basis for a trader to think the S&P has a better-than-average chance of closing this week and next week above last Friday’s close. There’s never any guarantee, but whenever traders have an idea of how a market should move, that knowledge can also come in handy when prices do the opposite.
The daily chart above highlights last week’s range (the last candle on the chart is yesterday). In this case, a push below last week’s low (especially a close below it) may suggest that the bullish dynamics that usually push prices higher after weeks like last week aren’t in play this time, in which case a change in the near-term outlook may be called for—another potential opportunity for short-term traders.