I’m not sure how yet, but this observation will change the way I trade.
Long-time readers will recall a previous post about daily follow-through and how it has evolved over the last 60 years. By follow-through I mean if the market is up today, how likely is it to be up tomorrow, and if it’s down today, how likely is it to be down tomorrow? But more importantly, how is the answer changing over time?
We showed the graph above of a 5-year rolling average of next-day returns following an up day (red) and a down day (blue) and concluded that for most of the last 60 years, the market has exhibited at least some degree of follow-through; up days tended to follow up days and vice-versa; however, since the mid-1970’s, this difference has been eroding, and since the new millennium, has actually flipped to contrarian; up days now tend to be followed by down days and vice-versa.
In this report, I’ll perform this same analysis, but separate out the first day of a new trading week (“weekend follow-through”) from all other days (“weekday follow-through”) and answer the question does Friday’s sentiment carry across the weekend?
The graph above shows a 5-year rolling average of next-day returns on the S&P 500 following an up day (red) and a down day (green) from 1950 to date for both weekends (light) and weekdays (dark). Geek note: returns have been normalized by subtracting the average return of all days in each observation period to remove the influence of bull vs bear markets.
KEY OBSERVATIONS
Generally speaking, weekends and weekdays have followed the previous pattern. For most of the last 60 years, both have exhibited some degree of follow-through; however, since the mid-1970’s, follow-through in both data sets has been eroding (with the exception of a data skewing October, 1987) and more recently has flipped contrarian. Up days now tend to be followed by down days and down days by up days.
But more importantly, these observations have always been much stronger across weekends than across weekdays. When follow-through was strong in the 50’s, 60’s, and 70’s, it was very strong across weekends. Now that it is contrarian, it is more contrarian (about 80% more).
As I wrote in the first report, absent other factors, follow-through (or the lack of) isn’t strong enough to be directly tradable, but it is strong enough that traders need to consider it as part of their overall strategy, especially across weekends.
And it continues to demonstrate that the fundamental characteristics of the markets (such as how much of Friday’s sentiment carries over to Monday) are in constant flux. We must adapt to the mood of the markets and be ever open to changing our assumptions about “the way things work”.
Happy Trading,
ms
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Filed under: Evolving Markets, Follow-Through, Stock Market Mechanics | 6 Comments
Michael,
Nine months after this was published, I’m finally getting around to asking a question: does this apply to days such as today (Thursday 7/2), since the market will be closed tomorrow?
And while I’m at it, what about Friday to Tuesday, for those times that the market is closed on Monday?
Thanks,
=Carlos=
RE to Carlos: for this particular study, I didn’t separate regular 2-day weekends from others…I treated every weekend the same. But you ask a good question and I’ve added it to my todo list to do a follow up post at some point on the topic. Thanks, michael
Thanks for the prompt reply, Michael. I’m interpreting your answer as saying that 3-day weekends and 2-day weekends were both included in the original study, and treated the same. Did I get that right?
Correct…they were both treated the same in this study.
Not sure, as I Disagree
This Week Day strategy works perfectly fine for me in Indian NIFTY markets context for the last 10 years.
Can you filter the trades for Friday follow through effect , with some other indicator such as ( 20 day low and or 20 Day high) , for increased profit factor