From the Desk of Trade Ideas

March 24, 2010

Dear Brett,

I just read your quick post regarding the “traps” the market can play on intraday traders and was inspired to model how a trader might separate real directional moves from mean reversion where stocks rise with momentum but retrace back to their previous levels precipitously.

One approach is to start with the assumption that mean reversions are the opportunity and not the trap. As a reliable stock scanning tool for recognizing custom patterns in price, volume, and volatility, Trade-Ideas is ideally suited for finding such moves:

Here’s a strategy that looks for moves beyond a stock’s standard deviation of volatility. It looks for upward thrusts defined as a price move of $0.50 or higher in the last 5 minutes on 250% higher than normal volume for a 5 minute candle in that stock.

Short: Up 50 Cents or More on Big Volume Spike

(Note: to import this into TI PRO copy the link address and paste it into the Collaborate dialog box when you right-click inside any TI PRO Strategy Window)

Using the OddsMaker, Trade Ideas’ event based backtesting tool, I realize the best way to trade the strategy is to short it and exit under either of 2 conditions: 1. if the stock goes up (against my position) more than $0.50 or 2. after a hold time of 45 minutes. I trade this strategy during the entire market session as opportunities arise.

Here’s the OddsMaker output from the last 15 days (picture attached). I create an additional measure from the report to evaluate a strategy and the trading plan associated with it: the ratio of the average winning trade over the average losing trade. I like to see at least a 2:1 ratio like I do with these results.

The second approach is to find the sustained movers and avoid the traps as you originally intended to define as opportunity.

Here’s a strategy that looks for moves where stocks are either out performing the Qs or increasingly diverging (upwards) from their VWAP, or the 5-period SMA crosses above the 8-period SMA using 10-minute candles. These alerts are subject to a universe where most notably the NASDAQ and the S&P are both up at least 0.1% over the last 15 minutes and that all opportunities shown are up at least 5% from yesterday’s close.

Long: Stocks Showing Strength Now

Using the OddsMaker I realize the best way to trade the strategy is to go long and exit under either of 2 conditions: 1. if the stock goes down (against my position) more than $0.50 or 2. after a hold time up until 5 minutes before the day’s close. Notably I only begin trading this strategy 60 minutes after the open and enter no more trades 60 minutes before the close.

Here’s the OddsMaker output from the last 15 days (picture attached). One additional measure I create from the report to evaluate a strategy and the trading plan associated with it is the ratio of the average winning trade over the average losing trade. I like to see at least a 2:1 ratio like I do with these results.

Feel free to try these strategies in real time. Happy to discuss and refine these with your thoughts!

Best regards,

David