Quantifiying how Market Analysis can Enhance Individual Stock and ETF Trading Methods

Stock traders are aware that it is generally beneficial to have the market on your side. Whether the market moves up or down will often have an influence on an individual stock or ETFs movement. As they say, a rising tide will lift all boats. Yet too often traders (especially short-term traders) either ignore the general market action or underemphasize it in their decision making. They’ll look for a trigger without carefully considering the likely direction of the market.

I have found trading with the general market on my side to be of great importance. In August I conducted a study for my gold subscribers that demonstrated and quantified this concept.


As part of their gold subscription, traders have access to 11 different swing trading systems. On the system pages they are able to see the rules, Tradestation code, and backtest results across 2 lists of securities. One list is the S&P 100 and the other is a list of about 100 ETFs. The ETF list looks just at equity ETFs. It does not include any inverse or leveraged ETFs and there are no duplicates in coverage (like SPY & IVV). Most of the systems were first published within a few months of the subscriber letter first being published over 2 ½ years ago. When updating all the original backtests in late August I decided to see how the system performed when there was a perceived market edge versus times there wasn’t.


Many readers are aware of my Aggregator tool. The Aggregator utilizes the market studies I publish in the subscriber letter (and sometimes in the blog). It uses them to generate short-term market projections. Aggregator configurations can produce a long, short, or flat bias. A more detailed description of the Aggregator can be found here. A post describing how the Aggregator has been used as a system can be found here. The bottom line is that the Aggregator is my #1 tool for setting my short-term market bias. It also has a history dating back to the inception of the subscriber letter so I can easily see what my bias was going in to any given day.


So to quantify the value of trading with the market on my side, I ran tests on all 11 numbered systems to show their performance over the last 2 ½ years. I filtered the results to show trades that were accompanied by a confirming Aggregator signal versus trades with a neutral or offsetting Aggregator signal. In general I found results to strongly favor entering trades at times when there was also a perceived market edge (confirming Aggregator signal). Below is a partial example of the results that are shown on the website. This is “System 80509”.  It looks to enter long trades in strongly oversold securities.

The discrepancy here is more substantial than was seen in many of the results. Still, the general results suggested you are much better off trading with the market winds at your back.


The lesson here is not that you need to utilize Quantifiable Edges systems or the Aggregator tool to enhance your results. It does mean that whatever trading methodologies you are using, you will likely stand a much better chance of success if you also incorporate some solid market analysis as a filter.


One last note for advanced system developers and testers. Complete historical Aggregator values are available with a QE subscription. You could easily download and apply them as a filter to test the effect on any of your own systems.

The 1st Profitable Close Exit Strategy - When It's Appropriate

Today I just want to touch briefly on the exit parameters for the “2 Days In Chop” systems that I discussed yesterday. The exit strategy is basically a time stop married with a “first profitable close” exit. For many traders, a “first profitable close” exit may seem like nothing more than a ploy to inflate the winning % of the system and not an appropriate exit technique to put into practice.

Sometimes this is true. In other cases though, the 1st Profitable Close exit is appropriate and effective. “2 Days In Chop” is one of those cases. Recall the premise of the system was based on taking advantage of the extremely choppy market conditions that had been identified. It’s those choppy conditions that make the 1st Profitable Close strategy viable.

When conditions are especially choppy and the market is constantly swinging back and forth, the expectation is for that chop to persist. This would suggest a move in the direction of the trade is more likely to be reversed than to follow through. So with a system like “2 Days in Chop”, the expectation flips as soon as the trade becomes profitable. Since a reversal is more likely than continued follow through the correct play is to take the quick profit.

Obviously an exit strategy like this only works well when trading a reversal / mean reverting system in a choppy environment. In a different environment, or if trading a breakout system, an exit strategy that looks for quick profits would be a disaster.

Other techniques that work well when trading overbought/oversold conditions would include using a short term oscillator and waiting for that oscillator to revert back to a neutral state, or using a short-term moving average (such as a 5-day) and then exiting the trade on a cross of the moving average.

2 Days In Chop Systems - 1 Year Later

About a year ago I showed 2 systems that looked to take advantage of the market’s choppy nature. Since that time I have tracked the performance of these two incredibly simple systems in the Quantifiable Edges Subscriber Letter. I’ve referred to them as the “2 Days In Chop” systems. As a quick refresher the rules for each are below:

Long System (2 Days Down In Chop):
1) Buy the SPX any time it closes lower 2 days in a row.
2) Sell the 1st profitable close up to 3 days later.
3) Sell on the 3rd day regardless of profitability.

Short System (2 Days Up In Chop):
1) Short the SPX any time it closes higher 2 days in a row.
2) Cover the 1st profitable close up to 4 days later.
3) Cover on the 4th day regardless of profitability.

A few quick notes:
At the time the market was locked in a downtrend which is why I gave the shorts an extra day.
I noted the systems were very raw and were not something I would trade “as is”.

Below I will show the combined performance of the 2 systems since I introduced them. In upcoming posts I’ll discuss how I use the systems and also discuss some thoughts on them and some ideas in which the basic systems could be improved.

Here is the performance over the last year +.



A 73% return would seem very impressive for something so simple. It has had a bit of a drawdown lately, though. Below is a profit curve.

The system peaked on 6/22 and has had a few rough trades as of late. Still, the recent drawdown is very small compared to the overall gains of the system.

So why haven’t I simply traded the system “as is” for the last year? I guess you could say that I’m just not smart enough to blindly trade a system this dumb.

I’m getting a little smarter, though. And I’ll have more in upcoming posts.

How Time Stretches Can Provide An Edge

While it seems the S&P has hardly pulled back at all since the March lows, one market that has made it the entire time without a single close below the 10-day moving average is Singapore. EWS has now closed above its 10-day moving average for 25 days in a row. When a stock or ETF spends an extended amount of time on one side of a moving average it creates what I refer to as a “time stretch”. I’ve discussed time stretches on the blog before but not for quite a while.

When a time stretch gets large, such as the current 25-day 10ma time stretch for EWS, you can often expect a move back to the other side of the moving average in the near future. I have found time stretches to be useful in system building.

To demonstrate, looking at the current EWS situation I set up the following criteria among my list of about 115 liquid ETF’s. (This list excludes all inverse and leveraged ETF’s.)

1) ETF must have closed above its 10-day ma for at least 25 days.
2) Today it closes at the highest level of the upswing.

Selling short under those conditions and then covering on a close below the 10-ma provided the following results over the last 10 years across my list of ETF’s:

Trades: 211
Wins: 167
Losses: 43
% Wins: 79%
Avg Win: 1.8%
Avg Loss: -2.1%
Avg Trade: 1.0%

As you can see, although the concept is simple, the results can be quite powerful. Traders may want to consider including time stretches in their bag of tricks. I use them for a few systems tracked in the Gold members section of the website and in Quantifiable Edges Subscriber Letter.

Some Simple Shorting Systems

When the market hits new highs it tends to excite the media. The S&P closed at its highest level since early February on Thursday. Such news may sound positive when delivered by an anchorperson. But since the beginning of 2002, when the market is trading below its 200-day moving average, there has been a strong tendency to pull back after hitting news highs. Below are results of some simple systems. These systems call for shorting the S&P 500 any time it hits an X day high while under the 200ma. The trade is covered when the S&P 500 next closes below its Y-day moving average.

All of the systems above have performed quite well on the short side. As you can see, hitting new highs really isn’t something bulls should get too excited about.

Even In A Bad Market - Chop Has Provided Short-Term Upside Opportunities

Last Thursday I showed an incredibly simple system with outstanding performance over the last 15 months. It basically sold short any time there were 2 up days and looked to exit at the 1st profitable close on or before day 4 – at which time it would exit no matter what. Incidentally, today’s drop would’ve been yet another winner for the system.

It’s not terribly surprising that a short-selling system has performed well over that time period. Fairly amazing is how a long-oriented system based on the same ideas can output numbers nearly as good. Below are system criteria reminiscent of last week’s studies:

Entry criteria:
1) The S&P closes lower two days in a row - buy on close.

Exit Criteria:
1) If the S&P closes above the entry price of the trade, sell on close. 2) Sell on the close of day 3 regardless of profitability.

Time Period: 6/1/2007 – present

Results - There have been 39 trades, 35 (90%) of which were profitable. The average trade made about 0.65%. Total profit over the period about 25.5% All trades are listed below:


Once again I should note that this system is a product of the environment and not a well-designed trading system. Entry and exit techniques are too raw for actual decision making.

That said, results were fairly impressive. There have now been 16 winners in a row going back to February and the market has seen a difficult time during that period.

Now that we've had two down days it's likely a poor time to try and jump to the short-side. Those that are already short may want to consider taking profits. Traders could also begin thinking long in the next day or so.

A Short System For Handling Chop

In my recent Trend vs. Chop series I showed how over the last 15 months or so the market has become more prone to chop and less prone to follow-through. Tonight I will show an incredibly simple system that would have fared exceptionally well over this time period. I’ll then discuss the possible value of such a system.

Entry Criteria:
1) The S&P 500 closes higher 2 days in a row AND
2) The S&P closes below its 200-day moving average then sell short on close.

Exit Criteria:
1) If the S&P closes under the entry price of the trade, cover on close OR
2) Cover on the close of day 4 if not profitable.

Time Period: 6/1/2007 – present

Results:

There have been 26 trades, 25 (96%) of which were profitable. The average trade made about 0.75%. They are listed below:



If you relax the entry criteria and don’t require the S&P to close below the 200ma, then there will be 43 trades – 41 (95%) of which were profitable.

Some thoughts:

Although the performance has been stellar over the last 15 months, this is not a great system. In fact, if you run performance back to 1960, it’s not even a winning system.

I’m not a fan of the exit criteria. It keeps winners small. With a little effort I’m sure traders could come up with a more profitable exit strategy – even if it meant suffering a few more losing trades.

The bottom line here is that the market has been especially choppy over the last 15 months. Once aware of this, traders should look to take advantage. Seeing the market move in one direction for even a couple of days should alert traders that they may want to take profits or consider a strategy to benefit from a swing in the opposite direction.

Lastly, this environment will certainly change. While the above system may not be a great “trading” system, it does appear to be a very useful “tracking” system. In other words, moves higher of 2 days or more have quickly reversed and provided the system a nice string of winning trades. Traders should be on alert for system failures, as they could be a sign that selling into up-moves may be falling out of favor and the market environment changing. Therefore they would need to adjust their approach to take advantage of the new, emerging environment.