Some things in the market are so simple that they seem too easy. Yet over the years, the market has rewarded simple strategies. Let’s look at one of them.
Imagine this: the market is down. Is that depressing for you, or do you see it as opportunity? Many traders sit on their hands during a down market and get in the buying mood when the market is rising. In fact, the opposite approach would likely improve their performance.
Let’s look at a some simple tests that demonstrate this concept.
What I am testing is commonly referred to as Daily Mean Reversion.
The Rules:
- Buy at Close When the Close will Be Lower than the Previous Close
- Sell at Close When the Close will Be Higher than the Previous Close
- No Commissions or Slippage
- All available history used for whatever security is tested
The Results:
This equity curve shows the SPY traded using the daily mean reversion setup from above.
- Net Profit 240.86%
- Annual Return 6.86%
- Winners 68.14%
Okay, this seems too easy, right? I mean it is MUCH easier to buy the market when it is going up. Let’s change the rules to buy after an up day and sell after a down day. This is called Daily Follow Through.
The results of trading daily follow through:
This equity curve shows the results of buying after an up day and selling after a down day.
- Net Profit -10.73%
- Annual Return -0.61%
- Winners 36.96%
While I’ve demonstrated this concept using SPY, it works similarly as well on QQQ and IWM.
Caveat: In real life, your trading frictions, commissions and possibly slippage, would mean this strategy would just churn and churn and would never really go anywhere. However, we can use this method to our advantage with higher beta stocks that are correlated with the indices.
For fun, if you want to throw out some symbols that you think would work well with daily mean reversion, leave them in the comments section and I’ll run the DMR tests vs. buy and hold and report the results.
Related Post: As Volatility Rises, Watch for Mean Reversion
nice …
some painful data points in between though .. which makes a strong argument for system trading and taking the emotional decision making process out
Yep. It is easy to quit right when things are at their worst and start again when things are at their best. The only way I know to NOT do that is to just keep trading and following the rules.
I would be very interested in a weekly mean reversion study someday.
Good idea.
Chips & Dips ….
Wood,
Two for you: NTWK and EK
jog on
duc
Ya know…I hate that it can Be This Simple….could easily modify v an MA too….say take only the trades in the direction of the close relative to the X MA. Like only take the buys when the close is over the 20/50/200, etc – or better yet – if the prior close was above….
BTW – PDip is just killing it lately – speaking of mean reversion. And of course, I sat this round out….:)
Oh – and a stock to try – let’s pick something nice and trendy like LULU – if you could run raw and then again v the 20 sma buying only if today’s close 20 sma, it’d be interesting to see the difference if any.
Merci – your work is thought provoking as always
Cheese: results were worse when requiring the close to be > MA(20). But in general, DMR hasn’t worked very well with LULU.
LULU Daily Mean Reversion
Net Profit = -17.40%
Annualized = -4.68%
Max DD = -76.35%
Avg. Trade = 0.09%
Win % = 65.56%
LULU Daily Follow Through
Net Profit = 412.28%
Annualized = 50.61%
Max DD = -68.95%
Avg. Trade = 0.92%
Win % = 38.84%
LULU Buy and Hold
Net Profit = 353.14%
Annualized = 46.04%
Wood – that’s fascinating….so a stock that’s trending does far better on the follow thru – but something that’s “flatter” like the S & Ps does best with mean reversion?
What to make of that? One wonder if stocks making new highs are excellent candidates for the follow thru idea – but if not, use reversion?
thank you sir!
Yes, Power Dip is catching back up. As of Thursday, the 20% per trade model was beating the S&P.
Markets are now under the influence of a major Bradley turn window for the next ten trading days, with the Tuesday thru the following Wednesday area a high potential for very erratic markets. The month ends on Friday. Continue to watch for margin requirements to be raised in the oil and commodities sector. This will hit as a surprise to many traders
I heard you are getting a free yearly subscription to the New York Times 🙂
lol. They deserve to go bankrupt.