Strong Stock Market Return Reversals and Future Trend

Are days with strong stock market return reversals predictive of the future trend? To check, we we use daily opens, lows, highs and closes of the S&P 500 Index to define the following:

• Reversal – days with both (1) lows more than 1% below the open and (2) highs more than 1% above the open.
• Reversal Down – Reversal days for which the close is less than 0.25% above the low.
• Reversal Up – Reversal days for which the close is less than 0.25% below the high.

These thresholds are arbitrary but generate enough signals for some testing. For each group we plot cumulative index returns over the next 21 trading days. Using S&P 500 Index daily levels as specified during January 1962 (limited by availability of daily lows and highs) through September 2022 (15,293 trading days), we find that: (more…)