Friday, November 21, 2014

What Happens When SPY Trades Above Its Weekly Bollinger Band

Today, the PBOC and the ECB both promised to provide greater liquidity to combat disinflation. US markets have gapped nearly 1% higher overnight as a result.

Coming after 5 weeks of gains, this gap will push SPY above its weekly Bollinger Band (20,2). Above a Bollinger Band means that price is more than 2 standard deviations away from the mean. At least in theory, 95% of trading should occur within a Bollinger Band. Trading outside of the weekly band is usually significant.

Let's review recent instances. In the charts below, the arrow is a weekly close over the weekly Bollinger Band.

Since mid-2013, markets have been down the next week 5 of 6 times. In the one exception, markets gave back all subsequent gains and more in the next month.

In 2012, the close above the weekly Bollinger led straight into a 10 week correction. In January 2013, markets continued higher in the following weeks, but it traded below that high in 4 of the next 5 weeks.

SPY never closed above its weekly Bollinger Band in 2011, which tells you how unusual this can be. In 2009 and 2010, it did so 3 times, each traded lower the following week, two of which preceded longer market weakness.

Today's move higher is another sign of market strength. We have seen this lead to further strength longer term. But there is, at least historically, a good chance that some of these gains will be retraced in the next week, or that consolidation will follow.

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