After A 3.5% One-Day Decline...

04/21/09 08:41:54 AM

by Mike Carr, CMT

The Dow Jones Industrial Average is generally lower a week later.

Security: DJIA
Position: N/A

On April 20, the Dow Jones Industrial Average (DJIA) fell almost 290 points. Triple-digit days have become almost normal these days in the eyes of many investors. But a move of more than 3% in a single day is still something that gets the attention of even most the seasoned trader. Common wisdom says to expect a rebound from a day like this. Testing shows that rebound may be short-lived.

Going back to 1920, there have been only 48 days when the DJIA declined by at least 3.5%. Eighteen of those days have come in the past 16 months, so this is definitely a historically volatile period in the market. Looking at performance in the days after a decline of that magnitude, we see that the market is higher 60.4% of the time the next day. That is some evidence supporting a rebound.

Two days after such a decline, the market is higher 62.8% of the time. However, after three days the market is usually lower, showing gains only 45.9% of the time. Five trading days later, the market has been higher only 42.9% of the time.

Looking at a longer time frame, a month later the market has been higher only 51.9% of the time. This is well below average.

History shows very few instances of a large one-day decline after large gains in the previous month. There are only five instances where the market lost at least 2% after showing gains of at least 10% in the previous month. It is not reasonable to draw conclusions from a sample size that small. This again shows how unusual the current market action is.

Conservative traders may want to lighten up on long positions, given the history of market movements after a large one-day decline.

Mike Carr, CMT

Mike Carr, CMT, is a member of the Market Technicians Association, and editor of the MTA's newsletter, Technically Speaking. He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing," and "Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends."