ETFs that rise or drop over consecutive days in a row have shown a very strong tendency to revert in the short-term. In our quantified strategy guidebook High Probability Trading with Multiple Up & Down Days, we’ve developed a reliable system for successfully trading ETFs exhibiting this type of behavior.
Through investigating how ETFs have performed after multiple days of movement in the same direction (both up and down) we discovered how to identify these high-probability opportunities and trade them both long and short, and even with options. Inside this latest addition to the Connors Research Trading Strategy Series you’ll find over 20 strategy variations that have shown winning trade trades of over 82% throughout our historical backtesting.
Enjoy the first chapter of High Probability Trading with Multiple Up & Down Days below to learn more about this consistent, powerful strategy:
At Connors Research, based on the data, we have uncovered a number of ways how markets really work. Our testing has allowed us to identify a handful of rules that traders can follow to improve their performance. Among those rules are:
- Buying pullbacks can provide the foundation for a profitable strategy.
- Buying on further intraday weakness usually increases average gains per trade but lessens the number of trades. The key is to balance these two factors.
- Take short positions when prices show short-term strength.
- Shorting on further intraday strength usually increases average gains per trade but lessens the number of trades. Again, the key is to balance these two factors.
- Use dynamic exits that adjust to the current price action. This rule will become clearer as you learn this strategy. After you understand this rule, you will be able to apply it to other trading systems.
The High Probability Trading With Multiple Up and Down Days Strategy will provide you with a quantifiable approach to implementing these rules.
Without quantification, books about trading strategies simply tell traders to “buy low and sell high”. That advice is meaningless to most traders. We have found that it is possible to identify when prices are low by precisely defining when a pullback has occurred. After buying at what should be a short-term low, exits allow us to take profits and move on to the next opportunity in the markets.
Short trades are successful when you sell high and buy low. With testing, we have verified that this simple idea can be implemented in a trading system.
Systems traders can only be successful when they follow the system rules. This can be challenging for traders. Following the rules requires discipline and your discipline will be put to the test during a losing streak. High probability trading strategies, like those presented here, reduce the number of losing trades and should make it easier for you to follow the system. In the following sections, you will see variations of the Multiple Days Down /Multiple Days Up (MDD/MDU) strategy that have historically been correct more than 80% of the time.
MDD/MDU strategies take advantage of the tendency of ETFs to demonstrate mean reversion behavior in the short-term. The mean of prices is a short-term moving average. When a stock becomes oversold, it has moved far below the mean and it is likely to bounce back towards the mean (the short-term moving average). Overbought stocks, those that show relatively large gains in a short amount of time, are likely to fall back towards the mean in the short-term.
Rather than guessing when an ETF has become oversold or overbought, we have quantified the meaning of those terms and tested what happens after an ETF becomes oversold or overbought. The level of success possible with mean reversion strategies may be surprising to some traders.
With a mean reversion strategy, we are pursuing small price moves that have a high probability of occurring. Over time, small gains of 2-5% in trades that last about a week add up to large winnings for disciplined traders.
In this guidebook, we use the term “ETF” to refer to both Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs). As you probably know, ETFs may track a commodity such as gold, a basket of commodities such as agricultural crops, a broad index like the S&P 500, an industry sector such as financials, the economy of a specific country like Japan or Brazil, or even a group of countries designated as “emerging markets”. A common feature of ETFs is that they tend to remove a great deal of company‐specific risk through diversification. This diversification tends to smooth the returns from ETFs, i.e. it reduces the price volatility.
Lower volatility means smaller moves, on a percentage basis, when the price of an ETF rebounds from an oversold condition. So why would we want to trade instruments that, as a general rule, have less price movement than stocks of individual companies? The answer is “consistency”. With the right trading rules, our trades will be profitable a very high percentage of the time, giving us nice, steady gains over the long haul.
Click here to learn more about High Probability Trading with Multiple Up & Down Days and drill down into the test results.