Fridays and the Weekend Effect

Gary Smith wrote the book “How I Trade For A Living” in 2000, coinciding with the bubble in tech stocks and the NASDAQ at the time. It became a brief hit because of his background as a non-professional, home-based trader but he was (back then anyway) consistently profitable. His book’s notoriety increased due to the criticism he had of technical analysis, fundamental analysis, and basically every other “popular” trading method. He said he never made money using any of the usual trading techniques, and he formulated his own methodology based on seasonals, market sentiment, and tape reading.

On his chapter on “The Nitty-Gritty Of Trading” Smith reveals some trading signals he uses when playing the stock market. Smith does not trade stocks directly, but uses tradeable index funds–the present day equivalent would be ETFs (exchange-traded funds). He also trades options and stock index futures. Because of this fact, I thought some of the methods Gary Smith introduced may be applicable to predicting the PSE Index moves.

Smith introduced a number of patterns, but for this discussion I’ll focus on an interesting one called the Friday-Monday Momentum and Momentum break pattern. To quote Smith directly:

One of my more reliable momentum patterns over the years has been the Friday-to-Monday pattern. Stronger-than-average strength on a Friday is expected to be followed by more strength on Monday (or Tuesday if Monday is a trading holiday). Conversely, extremely weak price action on Friday is expected to lead to more weakness on Monday. A Friday-to-Monday momentum break pattern occurs when the expected strength or weakness on Friday doesn’t carry over to Monday. These weekend momentum break patterns are highly significant and indicative of a short-term trend change.

Makes you think for a minute why this phenomenon could even exist, or should even matter to traders? My personal opinion is that a weekend break is a significant period for traders, for many reasons. I call this the Weekend Effect:

1. Weekends are a time when traders have more time to assess their trading performance and strategies against the market action of the previous week, and time to prepare further strategies for the coming week.
2. Weekends are times when events could occur that either support or negate the action of the market in the prior week. Unexpected surprises and breaking news can occur during weekends.
3. Fridays, being the last day of the week–also commonly mark the close for traders analyzing market trends based on weekly data.

With that in mind, we can examine Smith’s first point: that significant action on Friday often predicts action after the weekend. In order to group the significant Friday results, I selected Fridays which had a closing greater than or equal to 0.75% of the previous close. I did quick calculation and found that the average percentage daily change for the index is about 1% (up or down), so by getting days that approximate or exceed the average, this would be filtering out the flat days.

Then having selected the significant days, I checked to see what the performance of the index was in the day following the weekend–usually Monday, but occasionally other days if the weekend was extended due to weather or holiday. Here is the result:

Now this is quite interesting. For down Fridays, the cumulative performance of the Index the next day was a loss of 1,424 points! This is sharply in contrast with a 1,737 gain for all other days. The winning rate for days following down Fridays is a measly 38% showing quite a strong bias for the next trading day to be negative.

For up Fridays, the cumulative return was 793 points also sharply in contrast with the 480 point loss for all other days (i.e. days which were NOT up Fridays). The winning rate was 54%, also higher than the 49% for all other days.

From these results, it appears Fridays are quite predictive, both in frequency and in magnitude, of the performance of the index after the weekend.

Let’s examine Smith’s second point: that if the action on Friday does not carry over after the weekend, this is an indication of a trend change. To do this, we can simply extend the data above, and add a condition for the next day. We can now test the performance of the index following if the down Fridays are not followed by a down day after the weekend, and the opposite if up Fridays were not followed by an up day after the weekend.

For days when an Up Friday is disappointed by a down day, the result is decidedly negative, cumulatively losing 198 points compared to a gain of 511 points for all other days. Expectancy is quite negative compared to breakeven for all other days. 

However when an Down Friday is surprised by an up day after the weekend, the cumulative result is breakeven, compared to a gain of 323 points on all other days. Expectancy is breakeven.

For this second part of Smith’s pattern, we have half an insight: only when Up Fridays are surprised to the downside is the pattern reliable. For the opposite momentum break, either the influence of a down Friday is far more potent to be overcome within one day, or this may also be due to a fact that I alluded to in my analysis of the OOPS pattern which has to do with the nature of the PSE as a long-only market. The result is that bullish signals are choppier compared to bearish signals.

Insight And Application

Along with my tests on Seasonality and OOPS pattern, one insight of these experiences is that there is far more to market dynamics than the conventional use of technical analysis and fundamental analysis. Although I also use price data in these studies, there is also a time-element in the patterns that deserve attention. More than sighting of trendlines, moving averages, and oscillators–which every other trader is already looking at, there are other factors at play that conventional chart reading will not be able to capture.

Furthermore, in my experience, very few traders actually go to the length of testing their ideas on paper and against actual data, and rely on the traditional strategies they’ve read or heard somewhere. This invariably leads to loss of confidence during bad times (which as the studies have shown, occur half of the time in most cases), and the result is that traders switch from one method to another without any consistency, and lose money.

More on the Friday effect–like seasonality, the reason this tendency persists is that the human action on these periods tend to be consistent. Whether the action is really due to the causes I mentioned earlier, or some other factor, the fact remains that action on Fridays are significant barometers.

Short-term swing traders can use Friday action as a signal of whether to enter, add, or close positions based on expected action on Monday. Meanwhile longer term traders can use both the Friday signal and the momentum break after the weekend as part of a signal to take profits or cut losses.