With Friday's sell off in the U.S. markets being followed by similar drops in Asia, traders have some decisions to make. Do you sell everything, hold everything and ride out the choppiness, or do you buy the dips and go long?
Being a long-term trend following trader (predominantly), I will be holding everything unless a stoploss is hit or my system issues a sell signal.
However, if you're seriously considering buying the dip, then let me tell you, history appears to be on your side.
A common strategy among system traders is to purchase stocks that have declined for several consecutive days and then sell the stocks after they have experienced two consecutive up days. The strategy is simple, very profitable, and it has the added advantage of minimizing your capital's exposure to the daily gyrations of the market.
The table below features the results of three backtests using the following entry criteria: four consecutive down days; five consecutive down days; and six consecutive down days. The exit signal, two consecutive up days, is the same for all three tests. Position sizing is 20 percent of capital per position. No stoploss was used in the tests, although using one is strongly recommended!
As you can see, the results are pretty impressive with net profits ranging from 383 percent to 480 percent over five years. While those are eye-popping profits, what I'm really impressed by are the risk adjusted returns (RAR) that are possible from this strategy. The RARs range from 640 percent to as high as 956 percent due to the fact that your capital is parked in cash much of the time.
Another advantage is the number of winning trades generated by this strategy. Many traders have a psychological need to have more winning trades than losing trades, even though a positive win/loss ratio doesn't necessarily translate into profits, so this strategy's 66+ percent win rate can help boost a trader's confidence while growing the account size.
After performing similar tests earlier this year, I tried trading this system but I couldn't bring myself to pull the trigger on individual trades because the charts were too atrocious looking, especially after five or six consecutive down days! Clearly the stocks were oversold and technically due for a bounce, but human nature intervened and prevented me from making trades that would have been profitable.
My hesitancy to enter the trades is a good example of why your strategy must fit your personality. If there is a mismatch between personality and trading strategy, then you won't implement the strategy consistently and the system's profit potential will never be realized.
I'm not giving up on this strategy though. My plan is to grow my existing account into the mid six figures, then set aside $50,000 in an auto trade account, that way I won't be tempted to look at a chart before placing a buy order, it will just happen!
Being a long-term trend following trader (predominantly), I will be holding everything unless a stoploss is hit or my system issues a sell signal.
However, if you're seriously considering buying the dip, then let me tell you, history appears to be on your side.
A common strategy among system traders is to purchase stocks that have declined for several consecutive days and then sell the stocks after they have experienced two consecutive up days. The strategy is simple, very profitable, and it has the added advantage of minimizing your capital's exposure to the daily gyrations of the market.
The table below features the results of three backtests using the following entry criteria: four consecutive down days; five consecutive down days; and six consecutive down days. The exit signal, two consecutive up days, is the same for all three tests. Position sizing is 20 percent of capital per position. No stoploss was used in the tests, although using one is strongly recommended!
As you can see, the results are pretty impressive with net profits ranging from 383 percent to 480 percent over five years. While those are eye-popping profits, what I'm really impressed by are the risk adjusted returns (RAR) that are possible from this strategy. The RARs range from 640 percent to as high as 956 percent due to the fact that your capital is parked in cash much of the time.
Another advantage is the number of winning trades generated by this strategy. Many traders have a psychological need to have more winning trades than losing trades, even though a positive win/loss ratio doesn't necessarily translate into profits, so this strategy's 66+ percent win rate can help boost a trader's confidence while growing the account size.
After performing similar tests earlier this year, I tried trading this system but I couldn't bring myself to pull the trigger on individual trades because the charts were too atrocious looking, especially after five or six consecutive down days! Clearly the stocks were oversold and technically due for a bounce, but human nature intervened and prevented me from making trades that would have been profitable.
My hesitancy to enter the trades is a good example of why your strategy must fit your personality. If there is a mismatch between personality and trading strategy, then you won't implement the strategy consistently and the system's profit potential will never be realized.
I'm not giving up on this strategy though. My plan is to grow my existing account into the mid six figures, then set aside $50,000 in an auto trade account, that way I won't be tempted to look at a chart before placing a buy order, it will just happen!
7 Comments:
Fundamental question with your backtesting--what do you do with stocks that first decline four days (so you buy), then decline a fifth (buy again?), then decline a sixth (buy once again)? A criterion is needed to signal a buy OR does the backtest count such an occurrence as three buys (one for each circumstance)? That would be 60% of your capital in a single (declining) stock!
I hope that makes sense. I've also looked at consecutive down systems, along with up, and find them moderately profitable, but always struggle with a criterion for entry...
Thanks and very good post,
Masterjaz out
Masterjaz,
Buy at the open after x number of down days. Exit at the open after two consecutive up days. Buy and sell are market orders.
This system does not martingale into positions. Just buy, then sell after two up days.
The key to this strategy and other trading systems is consistent execution over an extended period of time (months to years) to allow probability and the law of large numbers to work in your favor.
One of the mistakes most traders make is constantly switching systems in a search for the perfect trading system. Perfection doesn't exist.
Instead, a trader needs to create one or two market-beating strategies, and then trade those strategies exclusively to allow the strategies to live up to their potential.
Good luck.
question.
which software do you use for backtesting?
Wealth Lab, the website. Hoping to have Wealth Lab the software soon.
huh?
huh
Wealth Lab the website is basically a stripped down version of the software that is available to Fidelity customers.
The software version allows for 10-year backtests instead of five, different position sizing options, a wizard for easy script creation, etc.
U.S. Fidelity customers get the software free if they have at least $25,000 in their account and make 125 trades per year.
People outside the U.S. can purchase the Wealth Lab software for about $600.
I don't have the Wealth Lab software yet because I use a Mac and need to install Windoze first.
What's a Mac?
hehe
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