Some traders believe that Tuesday’s market reverses Monday’s. In other words, if the market rises on Monday it will fall the following day, and vice versa.
Is this true?
The following chart shows the change in the FTSE 100 Index on-
- Tuesdays when the market has risen the previous day (Monday up), and
- Tuesdays when market has fallen the previous day (Monday down).
The data analysed covers two periods: 1984–2012 and 2000–2012.
For example, in the period 1984-2012, the market rose on average 0.02% on Tuesdays following a Monday increase.
As can be seen, for the longer period of 1984-2012 the theory that Tuesday reverses Monday does not seem to hold. For this period, when the market falls on Monday the return is positive the next day (which is fine), but when the market rises on Monday, average Tuesday returns are positive as well (i.e. no reversal).
However, since 2000 the theory appears to be working rather well. Tuesday returns have on average been the reverse of Monday. In fact, when the market is down on Monday, the average returns the following day have been five times greater than the average returns on all days since 2000.
How can this be exploited?
The following chart shows the value of three portfolios since 2000 (all starting with a value of 100):
- Portfolio 1: tracks the FTSE 100 Index
- Portfolio 2: if the market is down on Monday this portfolio goes long the market at the end of Monday and closes the position at the end of Tuesday (for four days out of five the portfolio is in cash)
- Portfolio 3: similar to the above, with the addition that it also goes short the market on Tuesday if Monday was up
By 2012 the market portfolio (portfolio 1) value would be 82, portfolio 2 would be worth 148 and portfolio 3 would be worth 196.
It’s interesting to observe that both portfolios 2 and 3 performed well during the steep market fall in 2007-08. Although of late the profitability of portfolio 3 has been falling.
The chart below looks at the effectiveness of the theory on a year-by-year basis for the period 2008-11.
It can be seen that while the theory worked well in years 2008 and 2010, it did not do so well in 2009 and 2011. The difference in profitability of portfolios 2 and 3 in 2011 is attributable to the market rising (relatively) strongly on Tuesdays following a positive Monday.