Thursday, August 28, 2008

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


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.


Anonymous said...

Hi Rob, great Blog! Love your analysis. But, looking at your Tue/Wed, maybe you are lagging a bit? Tue piece seem to be bullish while Wed is not... so we are going now which contradict your wed piece but validate your tuesday piece, so maybe nex few day will validate your wed piece?

Rob Hanna said...

The studies are not meant to be a complete market analysis. They are a snapshot of one or two indicators and how the market has performed following similar setups. I provide more detailed analysis of the studies and my interprestation of them in the newsletters.

One tool I use to help visualize the net influence of different studies is the Quantifiable Edges Aggregator. See my post from early July for more information on this.

That said, I do suspect the market is going to pull back a bit in the next few days.

Unknown said...

Excellent idea, Rob. The great thing about numbers is that they allow us to quantify our feelings and hunches. Keep up the great work.

Anonymous said...

Rob I do remember you said in your previous post that this rise from july has been mostly 2 day in a row and pull back and that you said if market pull a 3 day up in a row, it might be change of character, you still think that's true? We had 3 day up and the up day are getting bigger each time. What do you think?

Anonymous said...

I don't understand the Exit Criteria which says Cover on the close of day 4 if not profitable.
What do you do on day 4 if the trade is profitable?