Nasdaq 100 Gap Down Strategy

January 3rd, 2011

I saw James Altucher’s post on articles he’s tired of writing each year and one of his ideas piqued my interest. He says:

…if a Nasdaq 100 stock gaps down more than 5%, its a good buy for the day.

I thought I’d check out this idea further by doing some backtesting. Over the past 2 years there were 234 instances where a Nasdaq 100 stock gapped down by at least 5%. I tested going long right at the open and then closing the position at the close the following day.

It turns out there is an edge going long in this situation. Here are some stats:

Win Rate: 55%
Average Gain: 0.73%
Profit Factor: 1.55

So it definitely looks like there is some edge there. Whether or not it is worth trading is another question. More testing is required to determine that, but at this point it’s probably worth working on or at least continued study to see what can be learned from it.

Mathematically Optimal but Psychologically Wrong

November 2nd, 2010

Here’s a good article that relates quite a bit to trading. John Cook discusses debt consolidation and the debt-snowball strategy. His point is that the even though it’s mathematically optimal to tackle higher interest rate debt first, in practice it’s more practical to tackle the smaller debt first.

There are a lot of parallels to trading with this. A good example is scaling out of trades. In most every strategy I’ve come across (and all that I’ve traded), the mathematically optimal strategy is to not scale out of trades but to keep your position until a stop or a target is hit.

In real life though this is often difficult to do. It only takes a couple trades where your target is oh-so-close to being hit and then ends up stopping out to see that scaling out could provide some psychological relief.

Another good example is using an optimal position size for your trades. Depending on your account size the optimal position size for your trading strategy might result in some really large drawdowns to weather. You have to take into account the psychological element – your theoretical backtest doesn’t care that it’s difficult to trade through drawdowns. 😉

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)

Follow the Trend or Reversion to Mean? You Decide

February 18th, 2010

A few weeks ago I read Paul Kedrosky’s post on how contrarianism is a fad and how he thinks that most contrarians are just posing for the camera. Jason Goepfert wrote a nice rebuttal (with an eye-catching title) about how there’s good reason to be a contrarian in certain situations. He used an example of the S&P 500, but how would the strategy work for individual stocks? You rarely see the types of forceful moves in the overall market that you do in individual stocks almost every day. Surely these types of moves generate some follow through.

I’ve done some backtesting in this area. So given this universe of stocks:

  • Price is between 0.50 and $60
  • Average volume is above 100,000
  • Volume on trigger day is greater than 2,000,000
  • The range on the trigger day is greater than 20% of the stock’s price
  • Volume on the trigger day is at least 50% above average volume
  • Closes at least 10% higher than its 10 day moving average

Here’s an example of ENT a few days ago:

(Chart generated by the StockTickr Trading Journal)

So my question for you: Is there a trading edge on the long side or the short side after these types of moves?

What’s your guess? Let me know in the comments below.

Backtesting Can Help Improve Your Manual Trading

October 29th, 2008

When I started automated trading a few months ago, I jumped head first into backtesting with the thought that it was essential to automated trading. While there’s no doubt that automated trading and backtesting go hand in hand, what I’ve discovered over time is that learning what makes automated trading systems tick (forgive the pun) gave me a much deeper understanding of the manual systems that I trade.

By learning how certain exit strategies affect the performance of high frequency automated trading systems, I inadvertently learned a lot about certain aspects of my manual system.

Some of my beliefs about my manual trading were reinforced, while other assumptions that I thought were practically 100% true were challenged by what I learn and continue to learn by backtesting automated trading systems.

For example, the time of day that you trade is absolutely critical. Strategies that make serious money at the open are often times completely worthless a half hour later (not all though).

There are other assumptions that I had about trend following systems and taking partial profits have been challenged.

One other thing I should point out is that sometimes taking the optimal action according to a backtest might not actually be the best course of action in your manual trading. For example, a backtest might tell you that taking partial profits (locking in a portion of your trading gains) is less profitable than not taking partial profits. What the backtest can’t calculate, however, is the peace of mind that can come from taking some of that profit off the table. Of course, we all probably make less than optimal compromises in our trading in exchange for some psychological comfort.

I’d highly recommend manual traders spend a little time backtesting strategies completely different than the ones they manually trade. Certainly if you’re a Trade-Ideas user already you should spend some time with the Odds Maker.

Backtesting Your Trading

September 23rd, 2008

This is the fourth in a series of posts about how and why and how I started down the path of automated trading. Here’s the first, second, third, and fourth posts in the series (RSS). Our automated trading robot is available now. Trade your own strategy automatically with no coding required.

Now there’s a word that means a lot of things to different people: backtesting. Ask 5 traders what they think of backtesting and you’ll get at least 5 different responses – from “backtesting is worthless” to “I wouldn’t even consider trading without backtesting first”.

Here’s my take on backtesting – it can be an extremely valuable tool depending on the trading system you use it for. In fact, in some type of systems it’s just not practical to start trading without backtesting first.

You’re At Step One Of…

One thing that a lot of new backtesters overlook is that backtest results are simulated. It doesn’t reflect actual participation in the markets. What often happens is someone develops a strategy that tests really well and then they start trading with it, fall flat, and then they get mad at the backtest. There are a whole variety of reasons that actual trade results don’t match up exactly with backtested results.

The important thing to remember is that when you develop a strategy that backtests well, you’re just at the beginning stages of trading a profitable strategy – there’s a lot more work left to do after this step!

Organize your Backtesting

When you set out to backtest strategies, it can quickly become overwhelming if you don’t have a plan for organizing results. It’s very easy to make adjustments and then lose track of what you changed and where you started – especially if you use the Trade-Ideas Odds Maker, which allows you to test strategies very, very quickly.

StockTickr has a built in “version control system” for trading strategies and backtest results – it allows you to archive, combine, and compare backtest results. You can even share a backtest with others if you choose to. So basically, StockTickr does all the heavy lifting for you automatically.

Compare the Backtest with your Actual Trades

It’s a depressing feeling when you trade a strategy, lose money, and then look at the backtest and it indicates you should have made money. Remember above where I said there’s a lot more work to do? This is where that begins. A lot of traders just abandon the strategy here or just start throwing a tantrum, but understanding why most strategies underperform the backtest is part of the process.

There are a lot of techniques to use to figure out how to get more money out of your automated trading system and comparing your backtest results with your actual results should give you some hints on where to start.

I’ll address these steps in more detail in the next post.