Despite the small sample size of 28 trades, there appears to be a significant edge here. From a sentiment perspective, the bulls seemed somewhat incredulous that the markets closed higher for a fourth day. Perhaps they will be more willing to sell tomorrow, sensing that the market has gotten ahead of itself.

The Method

This study will short the [SPY] at the close if the following two conditions are met:

1. The ETF will make four consecutive higher closes, AND

2. The four day rate-of-change will be greater than 5%.

The exit is a simple time-based exit.

100K per trade was used, with no compounding of gains. No commissions or slippage was added.

There were 28 trades generated from all of the available SPY data.

The Results

Net Profit stays positive even when holding short position for 20 days. I interpret this mean to that these setups often mark intermediate tops.

Almost 80% of trades are profitable on the next close. Note how the measure drops off smoothly through the 6 day exit and then becomes volatile.

Win/Loss Ratio is volatile but gives a rough average of 2.00 This means the average winning trade is twice the size of the average losing trade. Also, it never drops below 1.00 which means the losing trades were never larger than the winning trades.

The average trade is profitable from day one (this is what my partner and I call an “entry edge”). Note that a $1900.00 average trade shows the market has moved down, on average 1.9% from the entry by the close of the 2nd day (day zero equals day of entry).

A Little More Information:

Using all of the same parameters (exit on close of bar 2) except removing the Rate of Change requirement yields a total of 164 trades, with 51.22% profitable, a win/loss ratio of 1.73, and an average trade of $286.00. I present this information to show that at the very least winners will remain almost twice as large as losers. Introducing the Rate of Change improves the chances of winning as well as increasing the size of the winners, presumably because a market that has made a large gain has farther to fall.

Summary:

Be careful jumping on the short bandwagon if the markets gap down on Friday. Further testing shows that this edge is often eroded in the overnight futures market. If you are already short, great. However, if our best average exit yields 1.9% and the market gaps down 0.9%, half the average return may be lost.