The Classic Monday Fade: Revisited
By Jim Slagle | July 16, 2008 | 2:19 PM | 2 Comments
Back on March 31st of this year, I wrote my first post here at greenfaucet entitled "Classic Monday Fade?" In this piece, I attempted to explain what I saw as an unfavorable daily setup evolving that morning in the major indices. Typically in a bear market, any significantly positive action out of the gate on Monday will result in decreased buying interest throughout the day, which often leads to a "fade" into the close. Sounds simple right? Well, I took some hits around the office for writing that piece, so I figure now that that some time has passed, it may be a good time to revisit it. This isn't a victory dance by any means, I just think now is a good time to elaborate on the topic.
Why do Monday fades tend to occur in bear markets?
First off, in a bear market, traders tend to sell into any strength. Also, buying interest by definition generally isn't as robust as it is in bull markets. Traders tend to place their bets early in the morning (usually as a result of bullish weekend news) and buying interest along with volume tends to wane into the close, not to mention the fact that many swing and day-traders are less inclined to hold their positions overnight in a poor market. This Monday was a classic example as a Barron's artice over the weekend alluding to a bottom in the housing market, brought some folks in off the sidelines. However, the buying soon dried up and the sellers jumped back in and regained control of the market.
Going back to my March 31st piece, I explained that quarter-end days usually result in a slide down on the S&P 500 during the final hour of trading due to the posturing of funds and institutions (window dressing) liquidating positions in an effort to shape performance (or at least the perception of performance) before the the new quarter begins. This only exacerbates the likelihood of a slide into the bell. I interpret this as a very favorable short setup.
Now that the foundation has been set, I thought it would be interesting to see if this strategy has been effective over the last 16 weeks. I am using the DJIA and S&P 500 as comparable benchmarks. The results are displayed below:
Chart courtesy of Julie Radziewicz - Amherst College
Notice that if you had bought the DJIA open on March 31st and sold it on July 14th you would have been down a whopping 9.5% over the 16-week period. So what happens if you had "faded" (went short) the DJIA on the open and covered on the close every Monday from 3-31 forward? Well, as the chart above indicates, you would have been up .80% on the DJIA and 1.42% on the S&P. Sure, you didn't knock it out of the park, but you certainly desecrated the market during that timeframe, outperforming it by 10.3% and 8.1% respectively depending on the comparable benchmark index used. Also, note that recent results have been expectingly better since we have "officially" entered a bear market in July.
If you are really comfortable with this strategy, you could employ the ProShares UltraShort Dow 30 (AMEX: DXD) or the ProShares UltraShort S&P 500 as your trading vehicle. (AMEX: SDS) These ETFs are leveraged 2x's the inverse of the tracking index. If you do decide to go this route, I would strongly suggest having firm stops in place.
Conclusion: Be skeptical of strong Monday bear market gap-higher opens and watch for the volume and buying interest to level out during the day.
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