Thursday, November 22, 2012

Review of Short Term Trading Strategies that Work

Larry Connors new book is reviewed Here. I strongly suggest that traders should buy this book. But, for starters, I am giving below the review by Damien.


In this review, I’ll go over each chapter in brief, but I won’t discuss the specific strategy rules as I think that would be unfair to the author. I will also be starting to confirm the tests outlined in the book, and post some follow-up on the systems and whether I was able to reproduce the results, and how as the strategy done recently.

Chapter Overview:

Chapter 1 - Introduction: Not much to say here.

Chapter 2 - Think Differently - Rule 1 - Buy Pullbacks, Not Breakouts: This chapter makes the convincing argument that buying pullbacks has, statistically, worked far better than buying breakouts. While this is not news to me, the chapter presents some compelling information.

Chapter 3 - Rule 2 - Buy the Market after it’s Dropped; Not after it’s Risen: Basically a reverse of the prior chapter that continues the mean reversion as a strategy argument.

Chapter 4 - Buy Stocks above their 200-day Moving Average, not Below: This chapter shows how buying stocks/ETFs above their 200dma has a significant advantage over buying stocks below their 200dma.

Chapter 5 - Rule 4 - Use the VIX to your Advantage…Buy the Fear, Sell the Greed: Presents a basic VIX system in outline form (covered more in later chapters). The basic idea is to buy when the VIX is stretched.

Chapter 6 - Rule 5 - Stops Hurt: This chapter presents compelling stats on how much stops of different kinds (time stops, % loss, trailing) hurt trading systems. And this is without a doubt true. One issue I have with this approach is that I’m not sure most people could survive the drawdowns caused by this approach. A second issue is that not having stops takes away some pretty attractive position sizing techniques such a percent at risk or an ATR-based stop. His argument would no doubt be that those hurt the overall performance of the system, but in my limited experience I’ve found you can get more return out a system using position sizing. You can also translate that into options position sizing as well.

Chapter 7 - Rule 6 - It Pays to Hold Positions Overnight: Here Mr. Connor points out, again, using statistics, that most gains are made overnight rather than intraday. Thus, he argues that one should hold overnight to maximize profits.

Chapter 8 - Trading with Intra-Day Drops - Making Edges Even Bigger: This chapter shows how buying on a limit price below the open price can significantly improve the edge of a system. Obviously, there will be fewer trades as the percentage below the open increases, but Mr. Connors shows how both the percent correct and average gain per trade goes up. Definitely interesting stuff that I will be using.

Chapter 9 - The 2-period RSI - The Trader’s Holy Grail of Indicators?: I hate the title of this chapter - whenever I see the phrase “Holy Grail” I immediately think to myself that it is about to fail. But regardless, this chapter provides a comprehensive look at the power of the RSI(2) indicator. I’ve covered this a fair amount on this blog, so I don’t think much more needs to be said. This chapter also includes the Cumulative RSI strategy that I’m going to be testing myself over the next day or so.

Chapter 10 - Double 7’s Strategy: Not much I can say about this chapter without revealing the strategy - it presents a good simple trading strategy for the SPY when it over its 200dma.

Chapter 11 - The End of the Month Strategy: Michael over at Marketsci has been covering similar territory - Mr. Connors presents a strategy for focusing on the end of the month as a system.

Chapter 12 - 5 Strategies to Time the Market: This chapter covers, not surprisingly, 5 strategies. It builds out the VIX Stretch strategy, and then showcases another VIX strategy, a TRIN strategy, another Cumulative RSI strategy, and finally a short strategy for the SPY. All are interesting.

Chapter 13 - Exit Strategies: Here Mr. Connors reviews different exit strategies and their qualities. These include: time-based exit, first-up close exit, new-high exit, close above a moving average exit and the RSI(2) exit. The author provides detailed analysis of each exit. One criticism of the book here: he does not include stats on the first-up close exit and the new-high exit.

Chapter 14 - The Mind: I thought this chapter would bore me, but I found it surprisingly interesting. Rather than going on with the classic “trading in the zone” approach that has been covered numerous times, the author structures the chapter as a series of questions related to systems trading. Example: “You lose money for eight consecutive days and you’re long multiple positions as the market is imploding. What do you do? Get out?” My reaction to many of the questions (not that one because I have an answer) was “hmmm….I don’t have a good answer”. So more food for thought. There is also a long interview with Richard J. Machowicz, a former Navy SEAL, that may be of interest to some people but not me.

Well written and easy to understand - even for someone without a lot of trading experience.
Very interesting strategy ideas - gave me lots of areas to explore. Favorites: Cumulative RSI and Double 7’s Strategy. Also interesting: the chapter on Exit Strategies.

The systems are a little lacking in detail. Are we entering on the close of the day the signal is generated, or on the open of the next day? While this may be somewhat obvious when looking at the charts showing entries and exits, I think beginning systems designers may find it confusing. The charts showing the sample trades don’t show dates - so if you’ve programmed the system and want to double-check the results, you have to do some guessing such as “When was the QQQQ between 52.50 and 52 on or around the 22nd of a given month?”
I actually find this a problem, in general, when people describe trading strategies in general. I’d love there to be some standard such as:
- Indicator calculation (if appropriate): n/a
- Buy on: Open of the day following a signal.
- Position Size: Current Equity divided by number of positions
- Indicator calculation: n/a
- Sell on: Open of the day following a signal.
Much of the work in the book revolved around stocks/ETFs being above a 200DMA - and thus, there aren’t a huge number of strategies that will currently work.
As mentioned above, the systems don’t use stops. This may be unrealistic for many people, and limits your position sizing options. Simply saying “take your equity and divide it by the number of positions” keeps it simple but also gives no idea, for the trader, as to how much to risk.
Most of these negatives are pretty small - and I would strong recommend the book. For the beginning system designer, this book would be indespenible. For the experienced designer, you’ll probably find a gem or two that will spark some ideas of your own.



Dinesh said...

Dear Sir,
Thanks. It seems a useful book. Flipkart has 2 versions of this book but currently both are out of stock.
It may be worth for you to write something which includes your real life experiences. For example, a) yesterday was a day to go long b) today was a no trade zone c) long ICICI d) long Axis Bank etc.
I am not sure whether that is possible because a lot of this comes from experience coupled with sixth sense which gets developed with the vast experience but looking forward to that.

Gulshan said...

I think you are re-publishing old blogs these days it seems that I have read these before but any way the information provided by you is always helpful for me I would like to read it again and again.