We present a quantitative measure of the relative potential of markets for relief rallies.
Relief rallies usually occur during bear markets and can last from one to several days. Short covering typically triggers these rallies. The drivers could include news or even technical signals.
In this article, we present a quantitative measure of the potential of various markets for relief rallies, the Relief Rally Index, or RRI. This index can be of use to option traders who are trying to profit from relief rallies due to their high potential.
In this article, we assume the security is in a bear market when the price is below the 200-day moving average. However, we can calculate the RRI using any other definition, such as a drop of more than 20% below the security’s previous all-time highs. In addition, we consider only daily relief rallies, but the calculation can also consider rallies over a given period. Furthermore, the calculation of the RRI can take into account different magnitudes for the daily return from the relief rally. In this article, we consider daily relief rallies of 5% and 8% as two examples.
Below is an example for the gold miners ETF, GDX.
Since inception, there have been 23 daily returns of more than 8% during a bear market (price below the 200-day moving average) and only four when the ETF was in a bull market (price above the 200-day moving average). The bottom chart shows that this ETF has been in a bear market 48.5% of the time since inception. This is a variable we will use in calculating RRI.
On the other hand, if we look at the SPY ETF, there have been only four daily relief rallies with a magnitude of more than 8% in a bear market and none during a bull market. This ETF has been in a bear market 22.7% of the time.
To effectively compare various securities for relief potential, it is necessary to normalize the number of relief rallies based on the duration of their time in a bear market. Therefore, we can use the following formula to calculate the RRI:
RRI = number of relief rallies / fraction of the time in a bear market
For example, if two securities, A and B, have the same number of relief rallies in their history but A has been in a bear market for most of the time and B has been in a bear market half of the time, then B has higher potential according to the RRI index.
The tables below provide the RRI index calculations for the 5% and 8% relief rallies for 28 popular ETFs. To access the full report, you must subscribe to Premium Articles or All-in-One.
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Charting and backtesting program: Amibroker. Data provider: Norgate Data
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