I determined some time ago that I would eventuallyÂ like to make the switch from discretionary trading to mechancial system trading.
Here are some previous posts from my old blog, over a yearÂ old, where I work through Tharp’s questions. I have listedÂ his book in the iBC library under my picks. If you are considering system development, or are early on in the process, they might make interesting reads.
Setting My Objectives Part 1: Self Assessment
Part 2: Defining My Objectives
Part 3: Defining My Objectives
Anyway, I’m excited because I’ve found a system that fits my objectives. Of course, this is the strategy that uses RSI(2) to enter and exit long positions in the ultralong and ultrashort ETFs.
BHH over at IBD Index has been doing some great work, and has helped to take this idea from its infancy into a mature system. Dogwood has alsoÂ made some great contributions. I will be tracking all the trades associated with this system on Covestor, and have put up a widget on the blog so that anyone can see at anytime how the system is working.
I’m putting this information all into one post so that when I receive questions I canÂ refer readers to one place for answers.
What Is the System?
The system creates a long entry into one or more ultralong or ultrashort ETFs when their RSI(2) closes beneath 10. The system triggers an exit from the ETF when RSI(2) closes above 80. The buy or sellÂ is made the morningÂ after the signal is generated.Â I am currently using only the ETFs which average at least 100K shares traded per day.
There has been a good deal of tesing concerning stop losses, and it seems thatÂ the minimum stop should be near 12%, although a looser stop may work well for traders with a higher threshold for pain. If one can stomach the drawdowns, maybe a stop is not necessary at all. That is not a recommendation, just an observation. I have also been testing time stops, and have found that they decrease net profits without a corresponding decrease in the drawdowns.
BHH has also added another condition, and that is that the ETF must be trading above its 50 day moving average. You can check the results of the strategy with that condition applied here: More RSI(2).Â I think you’ll find the results promising, to say the least. The use of a percentage stop, coupled with this condition, seem to have minimized the drawdowns producedÂ during earlier testing. Right now, I am not using that condition, although I may switch over to using it, soon.
The system typically produces better than 70% winners. This number will change based on any stops or other conditions that are applied.
Possible flaws in the system are introduced by the fact that most of the ETFs have not been trading for even a full 2 years. In order to account for his, I tested the S&P, Dow Jones, and Nasdaq, for at least the past 20 years. The ratio of winners to losers was very similar to the ETFs, but the annual returns and net profits were not nearly as good.Â Regardless, the system was stillÂ profitable but did notÂ beat the indexes. Part of this can be mitigated by the fact that you were only invested about 33% of the time.
The beauty of the system is whenÂ it isÂ appliedÂ ETFs. TheÂ ETFs areÂ leveragedÂ 2xÂ and offer the opportunity to be both long and short. This is why it should beat the indexes.
There is still work to be done on this system. When multiple signals are generated, which ETF should be chosen over another? Also, is the 50 day average the best average to use?
As these questions are answered, and as success is hopefully achieved, I will update this post with future results.