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The S&P's Looming Break: Trade It or Fade It?


You're looking for three things.

Everyone has been watching the range on the S&P 500 over the past month. The index hasn't been able to close much above 1110 or below 1085 since early November, and that's making folks very anxious.

The common interpretation of this kind of volatility coil is that once the index breaks one way or the other, it's going to keep moving in that direction. It's kind of a pat answer that's taken from the textbooks (which aren't always right when subjected to historical analysis), so let's test it.

What we're looking for are three things:

1. The difference between the highest and lowest close over the past month is less than two times the Average True Range.

The S&P 500 hit a 52-week high sometime in the past month.

The S&P then trades at either a one-month high or one-month low.

Buying the S&P at the close of the day that it breaks to a new one-month extreme yields the following results when holding the trade for a week:

Breakout to a new high: 77% winners (20 out of 26 trades), +0.7% average return, 2-to-1 reward-to-risk ratio.

Breakdown to a new low: 36% winners (10 out of 28 trades), -0.1% average return, 0.8-to-1 reward-to-risk ratio.

So for the short-term at least, trading in the direction of the breakout seems to have some historical backing.
No positions in stocks mentioned.

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