Monday, July 21, 2008

Follow Through Days Quantified

Now that the market has bounced and a potential bottom has been established, CANSLIM and other intermediate-term traders are awaiting a Follow Through Day (FTD). Back in January and February I wrote a series on Follow Through Days and deconstructed them, showing actual statistics based on different assumptions and parameters. If you haven’t seen that series of posts and you trade in the intermediate-term time frame, I’d encourage you to check it out.

Below is a quick summary of my quantification of FTD’s:

1) While I’ve read claims of success rates as high as 80%, using extremely generous assumptions my studies showed success rates of about 55% since 1971.
2) Using the original 1% thrust higher requirement, every rally since 1971 would have been accompanied by a FTD. Increasing the requirement above 1% as IBD has suggested in recent years would have seen several substantial rallies occur without FTD’s
3) In most circumstances the FTD occurs close enough to the bottom for traders to be able to catch a substantial portion of a successful rally.
4) Market action in the days after a FTD has been a decent predictor of whether that FTD is likely to succeed.
5) Leadership may not emerge until some time after the FTD. Traders should not expect it to be present and obvious immediately.
6) FTD’s tend to be more reliable after small declines than large ones.
7) FTD’s after day 10 have had a higher success rate over the last 37 years than FTD’s that occurred between days 4-10. This is contrary to what is typically taught.

For those traders who use Tradestation and would like to conduct their own research, I have now released the Quantifiable Edges Follow Through Day Study on the website. It can be downloaded and tweaked as soon as you order. As with all the studies, the code is open and there are flexible inputs for further research. Here’s an example of how results may vary depending on your inputs:

In the original post which discussed success rates, the assumption I used to label a FTD a failure is that the S&P had to CLOSE below its downtrend low. I did this at the time because I wanted to make the inputs a generous as possible to try and reach the 70%-80% success rate that was claimed. Here’s a graph of the S&P 500 going back to December to see how this would have looked.

If I change the requirement from a CLOSE below the low to an intraday LOW below the low, the results change significantly. Now the success rate drops from 54% down to 45%. Most people might consider this an even more accurate representation. The chart with the adjustment to that input is shown below:

If you trade intermediate-term I’d recommend you learn all you can about this tool. Understand the true quantifiable value of Follow Though Days. Don’t just buy into the hype. Research it yourself. For those with Tradestation, the Quantifiable Edges Follow Through Day Study can be a great place to start.


Anonymous said...

Firstly, I want to congratulate you on your blog. I believe the approach your advocate, rooted in historical analysis, is very valuable to the novice and expercienced trader.

Secondly, on the FTD, you raise some interesting points. However, the value of the FTD is that it provides a definable way in which to quantifiably look for a low. As well, O'Neil has provided adjuncts to the FTD that enable a trader to determine the strength of the FTD.

In any event, the FTD is only 1 part of a bottom-up approach to trading. If the stock strenght is not there in potential leaders, the FTD is worthless.

Jeff said...

I love your FTD posts Rob. Great myth-busting.