A Trader Journal

Many people approach the market with assumption that only ideas that are complex or arcane can provide an edge in the markets. Unfortunately most trading books and vendors promote this assumption to sell their own services. Would you buy/subscribe otherwise? Another culprit is the notion that the more complex and intellectual a method or concept is, the better it is. Typical justification, otherwise everyone would have figured it. Another reason - intellectual addiction.
 
Sometimes simple things can provide an edge. Partly because they tap into simple basic emotions we all have as humans. For example, remember the last time market (SP500) had a strong sell off and closed near its lows. If you are visual, think of a large big red bar. What was your thought pattern and reaction? What sense did you get from financial media and popular blogs?

My guess is in both cases, it is a negative emotion followed by intellectual/logical reasons to justify market sell off and continuation of it. We know majority people are bad at timing. So how about taking other side of the crowd? This is where the price action research of this post comes in.The purpose of the study is to see what are the market returns when we follow the crowd vs when we takes opposite side to the crowd. 

Using SP500 (SPY) market as an example, one simple way to define crowd behavior for the day is based on the market close with respect to its high, low and close of the day. There are multiple ways to identify but for this test how about we define crowd behavior as follows -

• The location of the market close with respect to its high of the day provides the emotional temperature of the crowd for the day. The farther the close from high of the day, the stronger the emotional temperature of the crowd.
• The location of the market close with respect to its open provides the emotional sign of the the crowd for the day i.e., down day = negative emotion, up day = positive emotion.
• To quantify above, let's divide the day's range (i.e., high - low) into 4 quartiles to identify in which quartile the market closed for the day. Following image provides a pictorial description of what I mean.

Definitions:

• Bull Market - Market is above 200 day moving average. 
• Bear Market - Market is below 200 day moving average.  
• Graphs Annotation - In below graph, on X-axis, label 25 means 0%-25%. Similarly label 50 (25%-50%) , label 75 (50%-75%) and label 100 (75%-100%).

Close_Test:

• Compute the quartile for today's SPY market close i.e., (0-25)  or (25-50) or (50-75) or (75-100)
• Buy market @ open the next day.
• Sell market @ open the following day.
• Calculate the performance stats.

Note: Another interesting test would be to buy @ close today near end of the day (instead of buying @ open the following day). This can help one to get in on overnight action. I assume most of this blog readers are likely end of day traders. So for the test, I am using buying @ open the next day.

Bull_Market_Test:

• SPY market close is above its 200 day moving average.
• Compute the quartile for today's SPY market close i.e., (0-25)  or (25-50) or (50-75) or (75-100)
• Buy market @ open the next day.
• Sell market @ open the following day
• Calculate the performance stats. 

Bear_Market_Test:

• SPY market close is below its 200 day moving average.
• Compute the quartile for today's SPY market close i.e., (0-25)  or (25-50) or (50-75) or (75-100)
• Buy market @ open the next day.
• Sell market @ open the following day
• Calculate the performance stats. 

Misc:

• Test Duration: 1996 t0 Current
• Friction less results i.e., no commissions, no slippage.
• Long only trades.

Fading vs Following Crowd Emotions

Results Analysis:
My observation is in general it takes lot more time to write blog and generate plots compared to time it takes to create a test or analyze market. I already spent lot of time on this post to provide something worthwhile and results are fairly clear cut. Look at the annotations on the graph - 

• Specifically the results of 75%-100% quartile for all three tests. 
• Results of this top quartile under bull and bear market regimes.

Note:
The above is not a system nor it is a recommendation. Just a research into of one of the market characteristics. Feel free to let me know your conclusions from results. Also feel free to agree/disagree. 

Wish you all good health and good trading!

"There is just one life for each of us........ Be yourself!"