The Power of Trading The S&P 500

The Power of Trading The S&P 500

Recently we’ve been working on an S&P 500 mean reversion strategy. The entry rules are very straightforward: When a member of the S&P 500 closes with a low ConnorsRSI value and satisfies one other filter, buy the next day on a limit order. The exit rule is even simpler: sell when ConnorsRSI closes above a predetermined threshold. All the details of the strategy and its historical performance will be described in an upcoming Strategy Guidebook that’s part of our Connors Research Trading Strategy Series.

Despite its simplicity, this strategy has generated very healthy historical returns since 2001. The top 20 variations had average gains per trade ranging from just under 10% to nearly 17%, even though the average trade duration was less than 5 days. Those same 20 variations have generated anywhere from 278 trade signals to over 800 signals since 2001, with success rates between 75% and 85%.

While part of the performance of this strategy can be attributed to robustness of the ConnorsRSI indicator, another important component is that it only trades stocks that are members of the S&P 500. As most people know, the constituents of the S&P 500 are some of the largest publicly traded US companies, and they cover a broad range of industries and market sectors.

You can find a high-level overview of the S&P 500 selection criteria as well as links to more detailed information here. What’s notable is that there are criteria in addition to market capitalization. When you trade S&P 500 stocks, you’re taking advantage of the fact that someone else has essentially pre-screened the market and provided you with a diverse, manageable universe of high-quality equities to work with.

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Click here to register for a free webinar with Larry Connors to learn about the most comprehensive data platform for trading the S&P 500 ever offered by Connors Research.

These stocks are generally very liquid, and most of them have options available. They also tend to be relatively stable, both because of the size of the companies and because of the amount of institutional money that’s invested in them. Obviously there are exceptions – Worldcom, Enron, and Lehman Brothers spring immediately to mind – but overall these are the stocks that people like to own.

Here’s another interesting tidbit: over the past decade, the average S&P 500 stock has outperformed the S&P 500 Index! How can that be? Well, the S&P 500 Index is a weighted index, so that companies with larger market caps have a bigger influence on the value of the index. The chart below compares the S&P 500 Index (SPX) with Guggenheim’s S&P 500 Equal Weight ETF (RSP), which started trading in April 2003.

Notice that the un-weighted index, RSP (shown in blue), has far outperformed the more common SPX, (shown in red) since 2003. Even since the crash of late 2008 and early 2009, which brought the two indices back to similar levels, RSP has approximately doubled the performance of SPX.

This observation takes nothing away from the SPX as an index. The weighting that’s inherent in the index is very useful when you want the fluctuations in the index to be representative of the overall performance of the US stock market, or even of the general health of our economy. The fact that an un-weighted version of the index outperforms its weighted counterpart simply emphasizes the quality of all the stocks which comprise the index, not just the biggest ones.

Coming full circle, this helps explain why it’s important to not only have a solid strategy, but also to choose the best possible trading universe to operate in.

If you have an account of $100,000 or more and would like to learn how to invest in S&P 500 stocks with an optimized balance of growth and safety, please click here to attend a live webinar on our S&P 500 Low-Volatility Growth Portfolio.