Archive for the ‘Strategy ideas’ Category

Rubber band (Elastic).
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Dr. Brett is always writing interesting stuff – this caught my eye today – Demand and Supply: Measures of Stock Market Momentum. In the article, he outlines a method for measuring market momentum by counting the number of stocks breaking over a Bollingerband and below it:

Significant momentum is defined by a stock’s closing above or below its Bollinger Band; i.e., above or below the volatility envelope surrounding its short-term moving average. The larger the number, the greater the number of NYSE, NASDAQ, and ASE stocks that are trading with significant momentum.

Well that’s right up my alley.  So I used the S&P 500 for my tests. And to make it more interesting, I compared it against another momentum indicator I look at – the number of stocks making RSI2 > 90 or RSI2 < 10. First, it’s interesting that the two are close. But what is also interesting is that there may be more subtly in the BB approach – for instance, during the most recent sell-off, notice how the line starts to fall off as the index trends down – perhaps indicating that the trend is weakening.

Here’s a graphic:


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The old stocks at :en:Chapeltown, Lancashire. ...
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Madoff goes to prison – frankly I am amazed that he plead guilty and it was all over so quickly.  I figured that he’d try and prove himself innocent – I wonder what he got in return?  A better prison?  An agreement to leave his wife alone?  I expect we’ll know the deal in the next few weeks as it comes out.  Bottom line – this guy deserves nothing except pain.

Ok – onto the market: one of my measures for the level of “overboughtness” in the market is the number of stocks hitting RSI2 greater 90 and the number stocks hitting RSI2 of less than 10.  Right now, on the S&P 500, we have 51.6% of stocks with an RSI2 of greater than 90, while the number of stocks with an RSI2 of less than is at 0.2%.

And, at the same time, we have the Skills Index going on a buy.  So, how to play this?  Short term, I’m looking at shorts (or longs in inverse ETFs), including (but not limited to): SDS, DUG, TWM, SMN and MZZ.  On a retracement, we’ll look at whether or not it makes sense to go long.  Again, we’ll look for a rise in the percent of stocks in the S&P 500 with an RSI2 of less than 10.  Now, this isn’t a timing indicator – it is meant to be a macro view of the market and where we are likely to go – but not necessarily when.  RSI2, like an oscillator, can get pegged.  So what makes sense here is to start legging into the trades.

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I don’t know about you, but I think Michael over at Marketsci has been publishing what I consider the best stuff on the web on adaptive systems.  It has taken me a while to figure out how to do this with my own tools (Mike does this all in Excel – which is amazing in itself), but I’ve put together a simple system for IWM (the Russell 2000 ETF) to play around with making a system adaptive.

In this case, the rules are rather simple:

Buy: Buy when the 9 day simple moving average crosses above a 6 day simple moving average.

Buy Price: Close of the day following a signal.

Sell: Sell when the 9 day simple moving average crosses below a 6 day simple moving average.

Sell Price: Close of the day following a signal.

Investment universe: IWM only.

Note that this system is trading rules that generally go against conventional wisdom – which is that a short term moving average crossing over a longer term moving average should be a buy, and the opposite for a sell.

Now, to make it adaptive, I’ve made it so that if a 250-day moving average of the equity curve of the above system is declining (value today is less than the value yesterday), I will adapt the system.

So how does it adapt?  In this case, again, to keep it simple for this example, I’ve made it so that it will simply trade the rule opposite.

Now, the equity curve and system here are nothing special – I’m just using it to get comfortable with creating an adaptive system.  It is pretty clear that creating such a system has more challenges than normal system development.  Questions to ask yourself are (and Michael, again, is the authority here):

  • What causes the adaption? Equity curve?  Consecutive winners or losers?  Daily returns?
  • How will the system change? Reverse the rules?  Go with a completely different system?  Modify the existing rules?

Below are the equity curves for the system – the top of the chart is simple IWM with the moving averages thrown on it.  The black line is buy and hold on the IWM, the blue line is the system as it trades using only the default rules.  The green line is the adaptive system.  The moving average on the blue line is the 250-day SMA that is used for the adaptation.  So, when the line is green, we’re in the default system, when we’re in the red, we trade the rules opposite.

This is really just a baby step on my part in this direction – and I have to thank Michael at Marketsci for both his contributions to the community around this core idea and for his personal help to me in discussions on the topic.


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I’ll be writing more about what I’m seeing in the market but I wanted to do a quick update on the Skills Index.  We now have a sell signal after the index quickly climbed to over 70.  Two interesting points about the performance:

  1. It rose very quickly to 70 – probably too quickly in my mind.  As a result, I was hesistant to put money to work on the long side while it was that high.
  2. The performance of the index in bear markets is consistent with what we’ve seen in past bear markets.  Meaning, we have a quick, large bear-market rally and then a swift retracement.  I’m thinking a lot about how to model for this in a system.

Here’s the index:


Now – similar to the way we trade the index on the upside, we don’t enter immediate but will, rather, wait for a retracement of this down move to look to enter on the short side.  More to come.

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41xtxgez2vl_sl500_aa240_I was recently sent a copy of “Short Term Trading Strategies That Work” by Larry Connors and thought I’d post a review. The book covers many subjects that I’ve spent a lot of time looking at over the last two years.  I gather that some of the book comes from previous articles posted by Mr. Connors on the TradingMarkets website – so for some it may be material that you’ve already read.

Overall, I found the book to be a pleasure.  Well written, short and to-the-point.  Most trading books I read, frankly, are fairly worthless because they don’t contain any testing.  Mr. Connors makes it a point of discussing a strategy and then showing the tests.  Obviously backtesting can only take you so far, but it is a good starting point.  Most importantly, the book gave me some fresh ideas to explore – something everyone can use from time-to-time.  While the book may cover too much well-tred material for advanced system designers, I think the book would be an excellent starting point for someone interested in learning about systems trading.

As a side note, I love the format of the book.  It is a large, thin, hardcover book.  Makes it a pleasure to read and reminds me of my childhood Tintin and Asterix & Obelix books.

In this review, I’ll go over each chapter in brief, but I won’t discuss the specific strategy rules as I think that would be unfair to the author.  I will also be starting to confirm the tests outlined in the book, and post some follow-up on the systems and whether I was able to reproduce the results, and how as the strategy done recently.

Chapter Overview:

Chapter 1 – Introduction: Not much to say here.

Chapter 2 – Think Differently – Rule 1 – Buy Pullbacks, Not Breakouts: This chapter makes the convincing argument that buying pullbacks has, statistically, worked far better than buying breakouts.  While this is not news to me, the chapter presents some compelling information.

Chapter 3 – Rule 2 – Buy the Market after it’s Dropped; Not after it’s Risen: Basically a reverse of the prior chapter that continues the mean reversion as a strategy argument.

Chapter 4 – Buy Stocks above their 200-day Moving Average, not Below: This chapter shows how buying stocks/ETFs above their 200dma has a significant advantage over buying stocks below their 200dma.

Chapter 5 – Rule 4 – Use the VIX to your Advantage…Buy the Fear, Sell the Greed: Presents a basic VIX system in outline form (covered more in later chapters).  The basic idea is to buy when the VIX is stretched.

Chapter 6 – Rule 5 – Stops Hurt: This chapter presents compelling stats on how much stops of different kinds (time stops, % loss, trailing) hurt trading systems.  And this is without a doubt true.  One issue I have with this approach is that I’m not sure most people could survive the drawdowns caused by this approach.  A second issue is that not having stops takes away some pretty attractive position sizing techniques such a percent at risk or an ATR-based stop.  His argument would no doubt be that those hurt the overall performance of the system, but in my limited experience I’ve found you can get more return out a system using position sizing.  You can also translate that into options position sizing as well.

Chapter 7 – Rule 6 – It Pays to Hold Positions Overnight: Here Mr. Connor points out, again, using statistics, that most gains are made overnight rather than intraday.  Thus, he argues that one should hold overnight to maximize profits.

Chapter 8 – Trading with Intra-Day Drops – Making Edges Even Bigger: This chapter shows how buying on a limit price below the open price can significantly improve the edge of a system.  Obviously, there will be fewer trades as the percentage below the open increases, but Mr. Connors shows how both the percent correct and average gain per trade goes up.  Definitely interesting stuff that I will be using.

Chapter 9 – The 2-period RSI – The Trader’s Holy Grail of Indicators?: I hate the title of this chapter – whenever I see the phrase “Holy Grail” I immediately think to myself that it is about to fail.  But regardless, this chapter provides a comprehensive look at the power of the RSI(2) indicator.  I’ve covered this a fair amount on this blog, so I don’t think much more needs to be said.  This chapter also includes the Cumulative RSI strategy that I’m going to be testing myself over the next day or so.

Chapter 10 – Double 7’s Strategy: Not much I can say about this chapter without revealing the strategy – it presents a good simple trading strategy for the SPY when it over its 200dma.

Chapter 11 – The End of the Month Strategy: Michael over at Marketsci has been covering similar territory – Mr. Connors presents a strategy for focusing on the end of the month as a system.

Chapter 12 – 5 Strategies to Time the Market: This chapter covers, not surprisingly, 5 strategies.  It builds out the VIX Stretch strategy, and then showcases another VIX strategy, a TRIN strategy, another Cumulative RSI strategy, and finally a short strategy for the SPY.  All are interesting.

Chapter 13 – Exit Strategies: Here Mr. Connors reviews different exit strategies and their qualities.  These include: time-based exit, first-up close exit, new-high exit, close above a moving average exit and the RSI(2) exit.  The author provides detailed analysis of each exit.  One criticism of the book here: he does not include stats on the first-up close exit and the new-high exit.

Chapter 14 – The Mind: I thought this chapter would bore me, but I found it surprisingly interesting.  Rather than going on with the classic “trading in the zone” approach that has been covered numerous times, the author structures the chapter as a series of questions related to systems trading.  Example: “You lose money for eight consecutive days and you’re long multiple positions as the market is imploding.  What do you do?  Get out?”  My reaction to many of the questions (not that one because I have an answer) was “hmmm….I don’t have a good answer”.  So more food for thought.  There is also a long interview with Richard J. Machowicz, a former Navy SEAL, that may be of interest to some people but not me.


  • Well written and easy to understand – even for someone without a lot of trading experience.
  • Very interesting strategy ideas – gave me lots of areas to explore.  Favorites: Cumulative RSI and Double 7’s Strategy.  Also interesting: the chapter on Exit Strategies.


  • The systems are a little lacking in detail.  Are we entering on the close of the day the signal is generated, or on the open of the next day?  While this may be somewhat obvious when looking at the charts showing entries and exits, I think beginning systems designers may find it confusing.  The charts showing the sample trades don’t show dates – so if you’ve programmed the system and want to double-check the results, you have to do some guessing such as “When was the QQQQ between 52.50 and 52 on or around the 22nd of a given month?”

    I actually find this a problem, in general, when people describe trading strategies in general.  I’d love there to be some standard such as:


– Indicator calculation (if appropriate):  n/a

– Buy on: Open of the day following a signal.

– Position Size: Current Equity divided by number of positions


– Indicator calculation: n/a

– Sell on: Open of the day following a signal.


  • Much of the work in the book revolved around stocks/ETFs being above a 200DMA – and thus, there aren’t a huge number of strategies that will currently work.
  • As mentioned above, the systems don’t use stops.  This may be unrealistic for many people, and limits your position sizing options.  Simply saying “take your equity and divide it by the number of positions” keeps it simple but also gives no idea, for the trader, as to how much to risk.

Most of these negatives are pretty small – and I would strong recommend the book.  For the beginning system designer, this book would be indespenible.  For the experienced designer, you’ll probably find a gem or two that will spark some ideas of your own.

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Geometrical interpretation of partial correlation
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I’ve decided to publish a tool for readers on a weekly basis – I’ll see if people have any interest to decide whether to keep publishing it or not.  The links below are to documents (in HTML and CSV form) that show the 50 day correlation between most ETFs available.  There are about 170 in the file.

Want to figure out what ETFs you should have on to be more “neutral” in your overall positioning?  Check the Correlation Tracker!

If you find it useful, let me know.  If there are aspects you’d like to change, let me know as well – I’ve considered, for instance, publishing it for different time ranges.  But I’ll leave it to the readership to see if anyone cares!

ETF Correlation Tracker – 50 Day (HTML)

ETF Correlation Tracker – 50 Day (CSV)

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Parity - US Dollars Not Accepted
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Bill Luby at Vix and More seems to be stealing all my post ideas, but I’ll go forward with this one anyway.  Damn you, Bill!

In any case – like Bill, I’ve been spending time looking at the correlation between the US Dollar and Oil (and commodities in general).  Here’s a chart:


That’s the US Dollar at the top, followed by the Oil index, followed by the 100-day correlation of the two.  Almost perfect anti-correlation.  So, with that in mind, I’m watching commodities right now – and also taking a look at FXE as a way to play the dollar.  And, as Bill pointed out, I wonder if this is a strong sign of inflation reemerging due to the endless dollars we are printing to fund Bailout Nation.

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One Two Three Four Five Six Seven
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On a recent post on Marketsci on the use of RSI2, Bill Luby of VIX and More posted the following comment:

Count me among the fans of RSI (2). I think you might get more interesting results — though with much more time out of the market — using 95/5 and 98/2 as break points.

Also, if everyone is jumping on the RSI (2) bandwagon, perhaps it is time to spend more time evaluating RSI (3) or RSI (4) strategies. Just a thought.

Nice work, as always, but why do I always feel like I am assigning homework when I comment here…?

Well, I agree Bill – you can’t keep assigning homework to poor Michael.  I mean, where is the rest of the collective quantitative testing blogosphere when you need it?  Michael’s doing all the heavy lifting!  So to help Mike out, I’ve done some testing on different RSI days to see what would happen.  I can’t promise the snazy charts of Mike’s blog, but I’ll just break it down here quickly.

I created a basic system that buys the SP-500 when the RSI(N numbered day) goes below 10 and sells when it goes above 90.  You could do a further optimization of the actual buy and sell levels – I haven’t bothered to do that here.  I next optimized the system by having it run through different N numbered days.  So, RSI(1), RSI(2), RSI(3), etc.  Here’s the results:


So, as you can see, RSI(2) seems to do a lot better across a number of metrics.  These include Expectancy, Sharpe and a few others.

Now, what if we altered the RSI days for both entry and exit – meaning, say we enter on RSI(3) < 10 but exit on RSI(4) > 90.  How does that look?


So once again, we see that RSI(2) seem to win across a number of factors.  Will this hold true in the future?  Who knows. Couldn’t you break it down further by period?  Absolutely.  But maybe I’ll leave something for Michael to do – the guy is so friggin’ lazy.  😉

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Pretty interesting – not sure I’d go out and short the whole market on it, but it is definitely an interesting data point.

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Apocalypse Now

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It smells like….victory.  Ok, enough of the bad “Apocalypse Now” jokes.  Market did what I expected today, so that was good.  Made some money via Big Bamboo (product of the brilliant Woodshedder).   The SPY has now retraced 50% of the move from last week.  This looks like a critical juncture to me.


I was expecting there to be a retracement of some short that would lead to a possible entry point on the long side, but once again the market showed that it does not like the long side.  To retrace 50% of a move in a single day is not a good sign.  So, I watch the trendlines and will react based on what Mr. Market gives me (or what some of my systems give me).  I’m not an Elliot Wave guy, but I use the level of the retracements to give me an idea of where we are.

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