The frequency of “reflex rallies” occurring in stock market downtrends has diminished after the GFC bear market. New financial products and crowded trades may have imposed a regime change.
For simplicity, we define a downtrend in stocks as the condition when the SPY ETF is trading below its 200-day moving average. As the chart below shows, the count of daily 3% reflex rallies was relatively high during the dot-com and GFC bear markets, but since then it has decreased significantly.
From the ETF’s inception to the end of 2011, the number of 3% daily changes in a downtrend was 64. Since 2011, the number has increased to 81. During the 2022 downtrend, there were only five 3% rallies, as compared to 31 during the GFC bear market.
The current downtrend may still be in its early phases, although opinions vary on whether it will evolve into a bear market. Based on the decreasing trend in reflex rallies, we do not expect a significant number of those. The cause of this decline may be due to a regime change caused by the introduction of new financial products, namely thematic ETFs, and a dramatic increase in short-dated options trading volume.
The decreasing frequency of reflex rallies could impact the profitability of some mean-reversion strategies that rely on them. From a different perspective, the decreasing frequency may also be due to products that try to harvest short-term gains in downtrends by taking advantage of mean reversion and causing crowded trades.
Regardless of the causes, which are difficult or even impossible to identify in the markets, trading is bound to get more challenging due to the proliferation of new financial products and an increase in options volume.
Subscribe below for notifications of new posts and updates from the Price Action Lab Blog and get the free PDF book “Profitability and Systematic Trading” (Wiley, 2008).
Premium Content
By subscribing, you have immediate access to hundreds of articles. Premium Articles subscribers have immediate access to more than two hundred articles, and All in One subscribers have access to all premium articles, books, premium insights, and market signal content.
Specific disclaimer: This article includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this article are for informational purposes only. See the disclaimer for more information.
Disclaimer: We only provide the articles for informational purposes, not as investment advice or actionable content. We do not warrant the accuracy, completeness, fitness, or timeliness for any particular purposes of the articles. You should never treat the articles as financial advice. The author of this website is not a registered financial adviser. Before subscribing, please read our Disclaimer and Terms and Conditions.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
If you found this article interesting, you may follow this blog via RSS, email, or Twitter.
