1.30.13 – The Beginning Of The End?

The market suffered its sharpest pullback of the year on news that the U.S. economy contracted at an annual rate of 0.1% in the fourth quarter, down sharply from a strong 3.1% growth rate in the third quarter.  The Dow Industrials pulled back 44 points to close at 13,910.42.  The S&P 500 Index lost .39% and the Nasdaq Composite fell .36%.  Silver and copper prices were up sharply and Treasury yields were largely unchanged.

UVXY, the leveraged short-term VIX futures ETF, soared 10.65% as volatility roared back into the market.  BOIL, the leveraged natural gas ETF, gained 4.32%. AGQ, the leveraged silver ETF, rose 4.12%.  Please click on the symbols for details.

The market pullback has opened the door to some opportunities to buy ETF’s that have been trending.  Case in point – EEM, the emerging markets ETF.  EEM has gained 20.6% since bottoming in June.  It has been trading within a range for over a year and is now pulling back from the resistance area, seen in the weekly chart below which you can make full-screen by clicking on it:

EEM weekly

EEM issued a buy signal on today’s close in the Multiple Days Down (MDD) strategy.  Described by Larry Connors 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 4 of the past 5 days.  This means closing prices were lower than the day before for 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 4 being the one day there wasn’t a lower close:

EEM

Today’s entry was at 44.15.  The exit will be on a close above the 5-day SMA, shown in gray.

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%.

Mr. Chris White, developer of the ETF Trading Bandit software which I’ve reviewed in the blog, ran a backtest on the Connors/Alvarez strategies, using the same ETFs and testing the time period from 1/1/09 to 9/30/12. Unlike Connors, Chris 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 2009 – 2012 backtest by Chris on the MDD – Long strategy with the open-open strategy had a %Winners of 64.66% and an average %P/L of .40%.  The average hold time was five days.  Close-close had a %Winners of 71.99% and an average %P/L of .42%.  The aggressive version performed better, with an open-open %Winners of 69.92% and an average %P/L of .52%.  The aggressive close-close version had a %Winners of 78.76% and an average %P/L of .65%.

I ran a backtest on EEM using the aggressive version of the strategy, from its inception date through today.  With 93 trades since the ETF started trading, the %Winners was 78.49% (before trading costs).  The average hold time was 4.3 days.  Of course, past performance is no guarantee of future results.

A pullback lasting just a few days is an opportunity to buy strong ETF’s that are in a confirmed uptrend.  In his books, Dave Landry talks about how to trade stocks that are in a persistent uptrend.  If the pullback continues for another day or two, there could be ETF’s that set up in a Trend Knockout pattern.  Should that happen I’ll have some fodder to discuss later this week.

And if does not?  Whether that happens is something we will know, in the fullness of time.

About Dave

David Steckler enjoyed 24+ years of experience as an investment counselor and portfolio manager before retiring. A former professor at Lindenwood University in Missouri, he also was a member and past president of the American Association of Professional Technical Analysts (AAPTA), and a member of the Market Technicians Association (MTA).
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