SPDR Dow Jones Industrial Average ETF (NYSE: DIA) gained 0.90% and SPDR S&P 500 ETF (NYSE: SPY) gained 0.79% on Friday. Despite the gains, both ETFs are heading into Monday’s open oversold with PowerRatings of 8.
PowerRatings were developed to take advantage of a stock’s tendency to “Revert to the Mean.” Time and time again, we have seen that when a stock falls too far below its 5-day simple moving average it will often “snap back” – often going far above the mean. Conversely, when a stock rises too far above its mean, above the 5-day simple moving average, it will likely snap back, often going below the mean. Both cases are illustrated in the chart below.
PowerRatings are based on the relationship between price and the 5-day moving average (MA) of price. The further prices move away from the 5-day MA, the stronger the tendency to snap back becomes. PowerRatings uses the 5-day MA and several other components to identify high probability trade entry points. This strategy was thoroughly back tested and the history of over 4 million trades was analyzed.
We know from back testing that PowerRatings can be used as the basis of a trading strategy. Detailed back testing has confirmed that the higher the rating, the greater the one week historical gain has been for stocks and ETFs with that rating. For best results, enter trades on stocks with a PowerRatings of 8 or higher with a limit order 3-7% below the previous day’s closing price. Higher % limit entries have historically shown a greater percentage of winning trades but higher % limit orders also reduce the chance of trade execution.
As an example of a trading strategy that can be used, in the past, buying stocks with a rating of 8, on a 5% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 72% of the time with an average gain of 3.9%. Other entries and exits also show high winning percentages and large average gains.
All data is as of the end of day on 9/26/2014.