Trend Follow or Reversion to Mean Follow Up

April 6th, 2010

A while back I posed a question about following a trend or reverting to the mean – two well known strategies. Given a specific subset of stocks defined in the post would the edge be long or short? Weijei‘s comment was very close to correct.

It turns out that there is a definite edge to the downside on stocks that have gapped up on heavy volume. If you buy at the open the following day and then hold until the next day’s open you’d end up with a win rate of 38% with total percent gain of -286%.

However, if you sold short at the open and held until the next day’s open you’d end up with a win rate of 68% with a total percent gain of 899%. There’s no doubt at least in the short term that there is more of an edge with a reversion to mean strategy with these types of stocks.

Here’s the same chart in ENT. It shows that there would have been a small gain by shorting the following day. Look also at the days after – it looks like there might be a longer term trend following edge worth exploring.

(Chart generated by the StockTickr Trading Journal)

2 Comments »

  1. Josh Said,

    April 6, 2010 @ 8:12 pm

    How can you have a loss greater than 100 percent?

  2. Dave Said,

    April 7, 2010 @ 7:43 am

    Good question, Josh! The percent gain/loss is not (necessarily) the percent gain/loss of your account. It is the percent gain/loss of each individual position. So for example if you were long a stock at 4.00 and sold at 3.00 then that is a 25% loss.

    If you had 3 more similar losses then the total would be -100%. You wouldn’t have lost your entire account in this scenario unless you risked your entire account with each trade (not recommended) 😉

    Position sizing is everything.

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