The Quantifinder Unveiled

Have you ever found an edge I’ve discussed on the blog to be helpful, but wished you could be notified to next time it set up? For example on February 25, 2008 I showed how the S&P has performed following 2 consecutive days where it has risen 0.75% or more. The results were quite bearish over the next 1-10 days. Most traders may have seen that and factored it in to their thinking at the time and then forgotten about it.

Those who instead incorporated it into their bag of tricks benefitted greatly. On March 27, 2009 I did another post which updated the results of the 1st study. It also showed how the setup had performed since 2008 study was published. Being aware of when the setup is occurring can benefit traders in numerous ways. You could use it to enter short positions, or exit longs, or tighten stops, or adjust position sizes, or whatever suits your trading style.

The problem has been that tracking so many edges can be an arduous task. Not anymore. Now being aware of Quantifiable Edges studies is as easy as pulling up a web page.

It’s Quantifiable Edges quantum leap in quantitative research…the Quantifinder!

The Quantifinder is designed to automatically search through Quantifiable Edges database of published research and extract anything that is applicable to the current day's market action. This includes studies based on price, breadth, volume, leadership, and sector rotation. It looks at both daily and weekly data across a wide range of indices. All applicable studies are then published on the Quantifinder page, where you can easily see their bullish/bearish tendencies and a description of the research. From there it is just a click on the study and the publication (blog, Subscriber Letter, or Weekly Research Letter) is automatically pulled up. This allows you to read what I've written about similar setups in the past. A screenshot of the Quantifinder is below.

Detailed information on the Quantifinder can be found here.

There are 2 versions of the Quantifinder.  The intraday version notifies Gold subscribers of potential edges as the market close is approaching. Then the end-of-day version shows what studies actually did trigger.

If you’d like to trial Quantifiable Edges and the new Quantifinder, then you may sign up for a free 1-week trial here.

So perhaps you’re wondering why I used the above study as an example? You’ll notice the Quantifinder is showing it has now set up again as of Friday’s close - “Blog 3/27/09” showing up in red (meaning bearish).

SOX Strength A Potential Bullish Sign

I’ve discussed a few times in the past that when the SOX rises in the face of a selloff it is often a good thing. In the 8/13/08 blog I looked at performance following times wherer the SPX dropped 1% and the SOX rose on the day. Below is a slight twist on that study that looks at returns following an SPX drop of 1% with an SOX rise of 1%.

(click table to enlarge)


Three to four weeks out you’re looking at 90% winners. The average S&P gain over the next 4 weeks was over 4%. Even the instances over the last year were followed by positive numbers over the next 3 weeks or so. They were 7/15/08 (+5.75% over the next 15 trading days), 8/7/08 (+2.73%), 12/9/08 (+1.64%), and 2/25/09 (+3.85%). Meanwhile, if you bought the leading SOX instead of the SPX the average 4-week trade across the entire sample set rose from 4% to 8.2%.

Score one for the bulls. (Although I’m still seeing several bearish studies as well.)

From a 5-day low to a 10-day high in 1 day

The market moved from the low end of its recent range to the high end on Tuesday. It’s quite rare for the S&P to close at a 5-day low one day and a 10-day high the next. Below is a table summarizing all such instances since 1960:



A negative bias seems to follow such occurrences over the 1-5 days.

A Simple & Powerful Timing Indicator

Today I am going to discuss a slight twist on an intermediate-term indicator that I’ve discussed before. The idea comes from Gerald Appel’s book “Technical Analysis – Power Tools For Active Investors”. In it he discusses a relative strength measure of the NYSE vs. the Nasdaq looked at on a weekly chart. The premise behind the indicator is that the market tends to perform better when the appetite for Nasdaq stocks is greater than the appetite for NYSE stocks.Part of this is due to the higher volatility of the Nasdaq, and part of it is due to investors willingness to speculate more aggressively when their outlook is positive. Critics of the indicator suggest the reason it works is largely due to the higher beta of the Nasdaq. That may be part of it, but it doesn’t mean the indicator is without value. In fact, whatever the reasons behind it, the indicator has been an excellent barometer over the years. In the book, Mr. Appel suggests using a 10-week relative strength indicator to measure this phenomenon.

Since I normally trade the S&P 500 and not the NYSE Composite, I applied the indicator to the S&P 500. Doing so, I found the results to be even better. The indicator is shown in the chart below.



The two lines on the bottom panel are the relative strength indicator. When the solid line closes above the dotted line that means the Nasdaq is leading the S&P. When it closes below the dotted line, that means it is lagging the S&P. To make it even easier to view I’ve made the line green when the Nasdaq is leading and red when the Nasdaq is lagging. As you can see, the Nasdaq is currently lagging.

The performance can be evaluated a number of ways. This first equity graph (courtesy of Tradestation) shows the points gained in the S&P 500 since June 30, 1972 – May 15, 2009.



As you can see, over the time period measured the S&P gained 1,341.27 points when the Nasdaq was leading. Meanwhile, the total points gained by the S&P over the period was 775.74. The Nasdaq held a leadership position just slightly more than ½ the time during the period. So almost twice the gains (points-wise) were achieved in nearly half the time. Not bad.

What if you started with a $100,000 portfolio and compared buy and hold to only holding when the Nasdaq led?

I decided to show these results in Excel.

These results represent returns from 4/19/1971 – 5/22/2009. They do not include dividends. The pink line is the growth of $100k in the S&P 500. The blue line shows the results of investing in the S&P only when the Nasdaq is in a leadership position and earning 0% interest otherwise. The yellow line shows results if instead of earning 0% interest, you managed to earn a steady 2.5% interest on your cash balance while not in the market. While 2.5% isn’t easily doable today, over most of the time period it was extremely low.

It appears the only period where the Nasdaq/S&P Relative Strength Indicator didn’t provide an edge was during the 1995-2000 boom market when you would have wanted to be invested basically the whole time.

The ending value differences are striking. By sitting out of the market when the Nasdaq is lagging and earning a minimal interest rate on your cash, returns more than tripled. Nearly $2,000,000 more would have been earned on an investment of $100,000.

The Nasdaq/S&P relative strength indicator is well worth keeping and eye on and is a useful tool for measuring the health of the market. I’ve recently added it as one of the weekly charts I track on the Quantifiable Edges members charts page.

I’ve also posted a few files on the free downloads section of the website that may be downloaded.

1) The 1st file is the Excel worksheet that shows exactly how the model was built and the returns calculated. It also includes the chart shown above. Anyone interested in using Excel for historical backtesting or modeling, or who would like to see exactly how the relative strength indicator was calculated, may find it useful.

2) The 2nd file is a zip file for Tradestation users. In the zip file is an eld with the indicator that you may apply to your charts and a strategy that will allow you to run your own tests. Also included in the zip file is a worksheet that has everything all set up. It was created in Tradestation 8.5 (build 2289). My understanding is that if you are using an older version of Tradestation the .eld should import fine, but the worksheet may not open properly. Therefore, after importing the .eld file you’ll need to set up your own chart to apply the indicator and strategy.

Anyone who is a subscriber, or has taken a free trial of Quantifiable Edges in the past, or has registered prior to downloading the Daily Trading Coach Historical Patterns Sample Spreadsheet is already registered to access the free downloads section. If you don’t recall or don’t have a password, just enter your email address and click on the “Don’t know your password?” line below the login box and it will be immediately emailed to you.

Here’s a link to the free downloads page:

http://www.quantifiableedges.com/members/freedownload.php

3 Lower Closes - A Largely Misunderstood Edge

The S&P 500 closed lower for the 3rd day in a row yesterday. Three lower closes is often cited as having an upside edge. And it does – kind of. That edge is often misunderstood, though. The first place I saw 3 lower closes quantified was in Larry Connors book “How Markets Really Work”. One of the chapters in the book looked at consecutive days higher and lower. It basically found that after the market has moved in 1 direction for several days, there is a tendency for it to revert.

He measured 3 lower closes in that book from 1989 – 2003. (All tests were run over that period. It wasn’t specific to this particular setup.) When Larry measured 3 lower closes he looked at any time the market had pulled back for at least 3 days in a row and then showed performance statistics for the following days. What many traders fail to realize when they review his research is that there is a large historical difference between “at least” 3 days in a row and “exactly 3” days in a row. I decided to examine this in some detail tonight.

First let’s look at a chart of buying the S&P 500 any time is has closed lower for at LEAST 3 days in a row and then selling the next day. Keep in mind, if it is down again day 4 it will be bought again. Same with day 5, 6, 7 etc. until there is finally an up day.



There are a few things to note here. First, trying to buy all 3+ day pullbacks prior to 1987 was a losing strategy. After that it the market showed less tendency to trend and an increased tendency reverse. Buying 3+ day drops became profitable. The period covered by the blue arrow shows the period covered in “How Markets Really Work”.

Now let’s look at what happened if you bought the market after 3 and only 3 lower closes. In other words, the third day lower was bought. The position was exited the next day. If the market continued to head south it was ignored. There was no further buying on day 4, 5, or 6.


There is a striking difference between the two graphs. There does appear to be a recent upside edge, but most of it is concentrated on some outlier trades that occurred in the last year. Until very recently there was no advantage to buying the third close lower in a row.

Why the stark differences? I believe much of the reason is due to the strength of the eventual snapback. The more stretched the market gets to the downside, the greater the snapback typically is. The “3 or more” study guarantees a winning trade in every sequence. In other words, it will continue to buy each day until it has a winning day. Only after that will the count reset. The further the market drops, the more vicious the snapback is likely to be.

Below is a table that illustrates this concept covering the time period of 1989 – present. The left hand column is the number of days the market moved lower. The right hand column is the average up day the following day. (Down/losing days are not looked at here.)


As I stated above, the longer the pullback, the stronger the snapback.

Also consider when snapback is most vicious…during bear markets. Note the two time periods on the 2nd equity chart where buying three lower closes has actually provided an edge on the 4th day. Those 2 time periods were during the current and prior bear markets.

So is there really an edge to buying (exactly) three lower closes? Recently during bear market periods – yes. Historically, no. Of course if you understand the mean reversion will likely eventually take place, you can still take advantage of the pullback. You will need some patience, though. Below is a chart of buying day 3 and holding for 3 days (rather than 1).

This chart looks more like the 3 OR MORE chart shown above. In this case it is due to the longer holding period. The longer you hold the more likely you are to participate in the eventual snapback.

The bottom line is that 3 lower closes may indicate the market is getting stretched. The market will likely bounce some time soon. It doesn’t normally offer much of a day 4 edge on its own, though.

This Morning's Gap

Looks like the market is poised to gap lower by over 1% this morning. Having already been down two days in a row, risk/reward typically favors the long side from open to close in these situations. It's something I examined recently here.

And any time there's a large gap about to happen you can always review the gap-related studies by simply using the "Gaps" label on the right hand side of the blog.

Links

I have some sizable projects going on and some detailed studies that are taking longer than normal to construct. In the next few days or week I hope to have some exciting edges to share. In the meantime, below are some recent/current reads that I found worthwhile:

Mr. VIX (Bill Luby) with some detailed thinking on how low the VIX may be headed over the short and intermediate-term.

Ray Barros on the role of chance in trading.

Dr. Brett with links to 17 posts on intraday trading patterns that he wrote over the last month.

Corey Rosenbloom with his take on intraday tick divergences.

Of course if it is linkfests you're looking for, you don't normally come here. My favorite places to find worthwhile reading include Abnormal Returns, The Kirk Report, Phil's Favorites , Greenfaucet, Mr. Swing, and Newsflashr.