Two Out of Three is Really Good

With apologies to both Meat Loaf and Jim Steinman (both sadly deceased), Two Out of Three Ain’t Bad is woefully inadequate for traders.  If we can find a pattern that appears to work two out of three times, it’s not “ain’t bad”, it’s terrific.  And it appears that index futures traders have latched onto one that has been working roughly that often this month. 

Traders are always on the lookout for patterns that work, and I’ve noticed one that has been working for them recently.  Like many, I’m somewhat a creature of habit, and one of those habits involves consulting certain news sources each morning, usually between 6:30 and 7AM (all times EDT).  Even when I’m not checking global markets and pre-market US futures, the sources I consult usually keep me apprised anyway.  And this is what finally allowed me to piece together the patterns.

One daily item is Bloomberg’s Daybreak report, which is published around 5:30.  They have a snapshot of ES futures in the piece, and more often than not those are flattish at that time.  They were today.  Another daily read is Yahoo Finance’s Morning Brief, which arrives around 6:00.  It is somewhat typical that futures have ticked up a couple of points by then.  This morning for example, Daybreak had ES flat and Yahoo had it +3.25.  As I page through other sources during the ensuing hours, sites like the Wall Street Journal and CNBC’s app often show a bump of another point or two.  It tells me that US-based traders are waking up and buying ES and NQ futures, perhaps reflexively rather than consciously.

Another time period to watch, one where I’m typically quite engaged, is 8:45 – 10:00.  US Economic reports are generally released at 8:30, so anything can and does happen in their aftermath.  But by 8:45 we usually have a better sense of whether the numbers will be truly market-moving or simply noise, so bullish traders start to feel emboldened once more.  One of my colleagues commented this morning how we seem to get a ramp just before the equity markets open, which anticipates another typical flurry of buying on the US open, before finding a level a half-hour later. 

The next flurry tends to appear just before European markets close at 11:30.  Those dour Europeans are the ones letting early morning futures languish most days, and then once they are out of the way, we can feel emboldened to rally once more.  Whether or not the Europeans are dour and impeding US markets is speculation at best, but it doesn’t matter if that is actually true – just that traders act as though it is true.  That next leg tends to top out around 1PM. 

After that it’s murkier.  If it’s an up day, we often get another push about an hour before the close, if not, we tend to meander.  Also, sometimes we get some profit taking right before the closing bell.  It’s more difficult to discern that outcome.

A quick analysis of the results over the course of this month shows that each of the first three strategies tends to work more often than not.  Buying at 5:30 and selling at 7:15 is marginally positive, but buying at 8:45 and selling at 10:00, and buying at 11:20 and selling at 13:00 has been positive roughly 2 out of 3 sessions so far this month.  Quite frankly, I have not had time to put these strategies through rigorous statistical analysis, but I don’t think that many of the traders who are routinely buying have done so either. 

Here’s the thing about speculative market environments: it doesn’t matter if a pattern stands up to robust scrutiny.  If there is an underlying trend, or market inertia, traders are incentivized to follow it.  In this environment, the usually secondary mandate of “don’t fight the tape” has taken precedence over the usual prime directive of “don’t fight the Fed.”  A long-time market participant commented to me that this is the most FOMO that he has seen in over a decade and I’m not inclined to disagree with him. 

As I’ve learned from experience, trends and statistical patterns work really well until they don’t.  Also, the more people that have jumped onto a trend, the more painful it is when they reverse.  If you’re buying reflexively, simply on the basis that stocks go up because they typically do, please keep that in mind.