A swift reversal in the price of the S&P 500

Key points:

• The S&P 500 closed at its first 21-day low after closing at a 42-day high
• The reversal occurred in eight sessions and within the context of a long-term downtrend
• After similar setbacks, the S&P 500 showed negative returns across all time frames

A price reversal in an established downtrend

The S&P 500 and other indexes continue to retrace the multi-month surge from the June low. The world's most watched benchmark reversed from a 42-day high (close) to a 21-day low (close) in only eight sessions.

Let's assess the S&P 500 outlook when the index reverses from a 42-day high (close) to a 21-day low (close) in 15 or fewer sessions. At the same time, the index must be below its 200-day moving average, and the average has declined for at least 80 consecutive days. I increased the reversal count and lowered the successive days below the average to give us a larger sample size.

Similar reversal patterns in a downtrend preceded negative returns

A swift reversal from a 42-day high (close) to a 21-day low (close) within an established downtrend typically occurs in significant bear markets. 1962 and 1966 are notable exceptions. In most cases, the S&P 500 closed at a lower low. Signals in 1958, November 1974, and 1988 are instances when the index failed to take out the previous low.  

The study shows seven additional signals if I increase the reversal count from 15 to 25 sessions. Returns, win rates, and z-scores continue to look unfavorable. The relaxed condition parameter picked up a signal in 1962, which happens to be another example of a significant retracement, but not an undercut of the low. 

What the research tells us...

The swift reversal in the price of the S&P 500 index from a 42-day high (close) to a 21-day low (close) in an established downtrend doesn't bode well for the bulls in the next few months. One cannot rule out a significant retracement or an undercut of the June low. If the S&P 500 closes at a lower low, I want to see a divergence in new lows, which was absent in June.