That other shoe hasn’t dropped yet but eventually it will. Until it does the market is likely to continue treading water like it did today, with the Dow Industrials gaining 30 points to close at 16,452.72. The S&P 50 Index ticked up .05% while the Nasdaq Composite slipped -.37%. Biotech and health care stocks have had great runs the past few months but they were big decliners today. Silver and copper prices were down sharply.
Earlier this week I wrote about Dave Landry’s Trend Knockout (TKO) pattern and how VPU, the Vanguard Utilities ETF, had made two TKO’s this week. Unfortunately VPU took out the knockout bar low yesterday so the trade was stopped out for a small loss of about 1.1%. Losses are a part of trading.
Quieter trading the past few days saw many indexes make narrow range bars this week. I watch for “NR7″ bars, which is when today’s range is the narrowest it’s been in the last seven days. Narrow range days are typically followed within a day or two by days of increased range. Narrow ranges are also found during consolidations.
When an ETF forms a NR7 pattern, one way to trade it is to place a buy stop order one tick above the NR7 bar high and a sell stop order one tick below the NR7 bar low. On entry day, if filled on the buy side enter an additional sell-stop one tick below the NR7 bar low. If filled on the sell side enter an additional buy-stop one tick above the NR7 bar high. This means that if the trade turns against you, not only will you get stopped out with a small loss but will reverse and go in the opposite direction. Trail a stop to lock in accrued profits, and if the position is not profitable within two days and you have not been stopped out, exit the trade Market On Close (MOC).
The selling in health care stocks today signaled a buy in XLV, the Healthcare SPDR, in Larry Connors Multiple Days Down (MDD) strategy. Described by Larry and Cesar Alvarez in their book “High Probability ETF Trading,” the MDD strategy is simple in concept. The long entry rules are as follows:
1) The ETF is trading above its 200-day SMA.
2) The ETF closes below its 5-day SMA on the entry day.
3) The ETF must fall at least 4 of the past 5 days. This means closing prices were lower than the day before for at least 4 out of of the past 5 days. If this happens you buy the ETF on the close of the fifth day (today).
4) Aggressive version – Buy a second unit (scale-in) if prices close lower than your initial entry anytime you’re in the position.
5) Exit on the close when the ETF closes above its 5-day SMA.
The most recent five days are numbered, with Day 2 being the one day there wasn’t a lower close:
When Connors and Alvarez backtested the MDD strategy against a group of 20 non-levered ETFs from their inception through 12/30/08, the average %P/L was .50%, there was an average hold time of 3.3 days, and the %Winners was 73.6%. The aggressive version had an average %P/L of .82% and a %Winners of 80.3%.
Using EdgeRater Pro software I ran a backtest using the same ETFs as in the book and testing the time period from 1/1/09 to yesterday. Unlike Connors, Chris White, EdgeRater’s developer, tested using an “open-open” methodology that buys and sells on the opening price the day after receiving the signal; Connors used a “close-close” methodology that buys and sells on the close of the day. Chris’ backtests showed that using the open-open method captures 84% of the gains reported by Connors and Alvarez using the close-close method.
The MDD – Long strategy backtest with the open-open strategy had a %Winners of 66.47% and an average %P/L of .44%. The average hold time was five days. Close-close had a %Winners of 73.23% and an average %P/L of .49%. The aggressive version performed better, with an open-open %Winners of 79.28% and an average %P/L of .73%. The aggressive close-close version had a %Winners of 72.01% and an average %P/L of .61%.
I ran a backtest on XLV using the aggressive version of the strategy, from its inception date through today. With 163 trades since the ETF began trading the %Winners was 77.91% (before trading costs). The average hold time was 4.36 days. Of course, past performance is no guarantee of future results.
Given the uncertainty in Europe it’s unlikely the stock market will make solid gains next week unless the situation is resolved, and even then there could be a “sell the news” reaction. Exactly what happens is something we will know, in the fullness of time.
Enjoy your weekend.