Do market returns on Tuesdays reverse those on Monday?
We first looked at this in 2013 (in this article), so time to see if anything has changed.
First, the following updates the chart to 2016 plotting Tuesday returns for the FTSE 100 Index split by whether the previous day’s returns were positive or negative. Two time periods are considered: 1984-2016 and 2000-2016.
For example, for the longer period, the average return on Tuesday when Monday was up is 0.02%, while the average Tuesday return when Monday was down is 0.09%.
While the figures have marginally changed from the previous study in 2013, the overall finding is the same: namely that the theory that Tuesday reverses Monday does not seem to hold. Since 1984 it has done so when Monday returns have been negative, but not when they have been positive.
As in the 2013 study, the theory has been valid for the market since 2000.
The previous study suggested that further analysis might include a filter on the size of the Monday returns. This is done in the following chart, where Tuesday returns are only considered if Monday’s returns were beyond a certain threshold (i.e. of a certain size). The (arbitrary) threshold chosen was 1 standard deviation for Monday’s returns.
It can be seen that limiting the analysis of Tuesday returns to just large movements on Monday (i.e. beyond 1 standard deviation) does help the reversal theory. In this case, if the market rises on Monday, then on average it falls the following day (albeit a pretty small average fall), and if the market falls on Monday, the market rises (fairly strongly) on the Tuesday.
Let’s now look at how the theory has been holding up in recent years.
The following chart is similar in design to the previous charts, but this time it plots the reversal results for the discrete years 2013 – 2016.
First, when the market is up on Monday, all four of the past four years has failed to support the reversal theory as Tuesday has followed with positive returns as well. When Mondays are down, in three of the past four years Tuesdays have seen positive average returns (the exception being 2015).
Exploiting the reversal effect
OK, so how to exploit this?
The following chart plots the cumulative value of a portfolio that invests in the FTSE 100 just on Tuesdays when the previous day saw negative returns. For the rest of the time it is in cash.
In the 2013 study a variant portfolio was also considered, that as well as going long Tuesdays following negative Mondays also went short Tuesdays following positive return Mondays. There’s currently not much point in considering this as the reversal effect is not working for positive Mondays.
So, instead the variant second strategy studied here is as above (i.e. long Tuesday following a negative Monday) but with a 1 standard deviation filter applied to the Monday return (i.e. the strategy only goes long on Tuesday if the Monday negative return is a greater than 1 standard deviation return).
Since 2000 it can be seen that the simple long Tuesday strategy out-performs the benchmark buy-and-hold FTSE 100 portfolio. The variant 1SD strategy only marginally out-performs the simple long Tuesday strategy, but does so with with a greatly reduced volatility.