What's Happened To "2 Days Up In Chop"?

A few weeks ago I discussed the performance of the “2 Days In Chop” systems. After doing extremely well through June, I noted the systems had faltered a bit lately. The primary reason for the struggle over the last few months has been that the “2 Days Up In Chop” system has done poorly.

Below is an equity curve of “2 Days Up In Chop”.

The poor performance of “2 Days Up In Chop” can be attributed the strongly trending rally that has taken place. “2 Days Up In Chop” triggered again on Tuesday afternoon. I effectively suspended use of it as an indicator a while back. Should the market top out or enter a period of consolidation, or even simply undergo a deceleration in its uptrend, then “2 Days Up In Chop” may begin working again. I’ll continue to monitor the equity curve as a gauge of market behavior. Equity curves of simple systems such as this are a nice way to look under the hood of the market and understand what’s working and what isn’t in the current environment.

The Trend vs. Chop equity curve is one I update weekly on the subscriber site. It shows the effect of buying all up days and shorting all down days. In a choppy environment the line will fall. A rising line suggests a more trendy environment. For more discussion on this chart you may see this post from a little over a year ago. A current chart is below.

As you might suspect, the strong move up has been accompanied by unusually trendy behavior.

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.

Trend Vs. Chop III - Weekly Bars

Last week I looked at trending vs. chopping tendencies for the market in both the daily and intraday timeframes. What I found is that in both time frames the market has evolved from trendy to choppy over time. Today I am going to look at weekly bars. I will also have some further follow-up later this week which look at the statistics of some of the “Trend vs. Chop” results.

I’m going to use the same “system” as last week to display weekly tendencies. The first test here buys on the close of any up bar and reverses to short at the close of any down bar. Like last week, the trades were at a constant $100,000 per trade for the entire period. No commissions or slippage are figured in to the test. A rising graph would indicate follow through is dominant while a falling graph would indicate reversals are dominant. Sideways action would suggest no tendency.


Unlike the daily and intraday time frames, which favored trendiness through much of their history until fairly recently, the weekly timeframe has been more prone to chop since the early 70’s.

As I did last week, let’s now break that down into upside follow-through and downside follow-through. You’ll see a large difference here. The chart below looks at the results of shorting down weeks.

In the bear market of the early 70’s this was profitable as the market tended to show persistent weakness. Since then, with the exception of a few short periods during bear markets, buying the dips has worked quite well.

Now let’s look at what happened if you looked to buy strength:

Upside follow through was strong through the 60’s and until January of 1973. That is where you see the peak near the left hand side of the graph. Since that time the market has gone through cycles that sometimes favored buying strength and sometimes favored selling strength. Thirty-five years later the equity of the system is right back near its peak 1973 level. It should be no surprise that the current spike down began in 2007.

These results shouldn’t come as much of a surprise to people who have spent time evaluating or developing swing-trading systems. When trying to take advantage of 3-5 day moves, it is generally easier to develop long-only strategies that perform relatively well over time than to produce short-only strategies that perform consistently well. Hence a big reason you see so many more long-only systems. Of course in 2008 so far shorting strength has been easier than buying weakness.

Trend Vs. Chop For Intraday Traders

Yesterday’s post looked at the propensity of the market to chop vs. trend. The basic conclusion was that the market has shown less tendency to trend and more tendency to chop over the last few years. This was especially evident when looking at a long-term chart.

Today I’m going to show the tendencies on an intraday basis. The break down will be similar to yesterday. The first chart shows results of buying any up bar and then exiting on any down bar. 15 minute bars are used for all the tests below.
A rising graph would show a propensity to follow through and a falling graph would show a propensity to reverse. A flat graph wouldn’t favor either. One note about all these graphs is that the day is closed out flat. There is no overnight holding since we are only measuring intraday tendencies. Throughout most of the 90’s, the easiest way to make money intraday was to find an uptrend an jump on it. As with daily bars, that seems to have changed over the last several years.

What about shorting down bars? How has that worked?


Similar to buying strength, shorting weakness worked well in the 90’s. Over the last few years it has struggled. Even with the difficult stock market performance this year, downmoves have shown a higher propensity to reverse than to continue. The May-June period was a notable exception.

Now for the combination. The rules are basically the same as yesterday buy on an up bar and then reverse and short on a down bar. Again – no overnight holding since intraday trends are the issue.

No surprise here –trending behavior was favored until around 2003 when the market shifted to a significantly more choppy environment. The most pronounced choppiness has occurred in the last year and a half, suggesting the last year and a half has rewarded intraday reversal trades and punished intraday trend trades more than any time in the last 15 years.

Now for the long-term look back. For this test I was able to run the data back a little over 25 years.

As was seen with the daily bars yesterday, the propensity to reverse rather than trend is a relatively new phenomenon. Intraday traders would do well to consider the consequences of these tendencies when developing intraday strategies.

How To Trade The Choppiest Environment In 50 Years

If you trade trend or breakout strategies and have found the market difficult in the last year or so, I’m about to show a prime reason for that diffuclty. Below is a strategy that buys the S&P 500 on the close of any up day. The position is closed at the close of a down day. Essentially your looking to buy strength and sit out weakness.


This strategy worked well in the 90’s, but since the market topped in 2000, it has performed poorly. Since the Spring of 2007 it has really accelerated lower. What this means is that performance following up days has been especially bad. It suggests the environenment has been especially choppy. Whereas strength begat strength in the 90’s, it has led to immediate weakness since.

Now let’s take a look at downside follow through. In this case the strategy is to sell short on any down day and then cover on an up day.


This was a break-even strategy through July of 2002. Since then it has done terrible. Interestingly, it’s done especially bad over the last year plus. Even though the market has fallen precipitously, the manner in which it has occurred has made it difficult to profit if you’re trying to short breakdowns. Down days have been followed by up days.

What about a combination strategy? Buy strength and short weakness in anticipation of further follow through. Below is a chart with the combo strategy:

Again, since March 2007 this strategy would have experienced an incredible freefall.

Perhaps it would be best to take a step back, though. In the next chart I show back to 1960 instead of 1993 in an effort to find other periods where choppiness has been so prevalent.


As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. This would suggest that strategies that may have worked well for forty years or more could be suffering greatly now. Traders should consider the current choppy market behavior when designing strategies. Buying weakness and selling strength is working better than buying strength and selling weakness. They could also monitor charts like these to see if tendencies begin to revert back to pre-2000. If tendencies do revert, adjustments may be needed.
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Update: I just saw that Dr. Brett Steenbarger also addressed this topic in his blog today. He looked at it from an international standpoint as well. Click here to see his findings.
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