Improve Your Short-Term Trading with Two Simple Rules

PowerRatings are the single most popular tool we have on TradingMarkets. In this article, we will show you how you can potentially improve your trading edge even further with PowerRatings. All it requires is the addition of two rules.

When we first published PowerRatings beginning in 2005, the simulated results were based upon a holding period of five days. If a stock had a PowerRating of 9, its simulated returns were based upon buying a stock on the opening and exiting the stock five trading days later. But, as we will teach you here, one can dramatically improve the simulated edges in PowerRatings further by adding two simple trading rules to them.

Here are the rules:

1. Only buy a high PowerRating stock (7 or higher) on a limit order below yesterday’s close.

2. Instead of using a static exit and waiting for five days, use a dynamic price exit by exiting the trade when the stock closes above its 5-day simple moving average (SMA).

By adding these two simple rules, the simulated returns rise substantially and expand the edges even more.

Here are the PowerRatings simulated returns from January 1995 to September 2006 using a standard five day exit.

Now let’s add the two rules mentioned above. We’ll only buy the higher PowerRatings stocks (7 or higher) on a limit order below yesterdays close, and we’ll exit on the opening the day following a close above the 5-day SMA. Here are the results when we add these two rules.

The first table shows what has happened by entering a high PowerRating stock on a limit order 3% below yesterdays close and exiting on the open the day following a close above the 5-day SMA. As you can see, not only does the average gain improve in all cases, but the % correct improves substantially too.

3% Limit, 5-day SMA Exit

Here are the results for using a 5% limit and using the 5-day SMA exit.

5% Limit, 5-day SMA Exit

Again we improve in all cases, and we now see the % correct rise to 70% going all the way back to 1995 on 149,715 trades.

Here are the results for using a 7% limit with the 5-day SMA exit.

7% Limit, 5-day SMA Exit

Even though the number of trades drops, the % correct rises to 72%, and the average gain per trade jumps to 5.08% per trade. The edges on the 9’s and 10’s are even more extreme, with three out of every four signals being profitable and returns rising to 9.06% per trade for those stocks which had a top PowerRating of 10.

Overall, by using a limit entry and a moving average exit, the gains rise substantially. The average gains for the 7's are more than nine times greater than the average gain of all trades in our database going back to 1995. And the stocks with PowerRatings of 10 have performed more than 25 times greater than the average gain of all stocks. Again, these tests go back to 1995 and include over seven million trades.

Here is an example of buying a high PowerRatings stock on a limit order and exiting on the open after it closed above its 5-day SMA. This trade was taken by us as we were writing this educational piece (please note that this is an extreme example and there are no guarantees of any future trades achieving these type of gains).

BWLD had a PowerRatings of 9 (see chart) on 02/13/07. BWLD gapped down more than 3% the following day and had an intraday drop of more than 4%. BWLD closed above its 5-day SMA on 02/15/07, then gapped up on 02/16/07. We exited the stock on the open for a gain of more than 19% in just two days.

One caveat to the above is that most days, PowerRatings are viewed by thousands of traders. Too many people entering or exiting at a fixed price, or on the open, will potentially have an impact on price behavior (and likely make at least a few specialists and market makers wealthier). Also, in low volatility environments (like now), fewer stocks trade to the 4-7% levels than in high volatility environments. Therefore, if you apply PowerRatings to your investing and trading, please be cognizant of these facts when entering and exiting positions.

We hope this information is helpful to you. If you would like to attend a free class which covers this research and strategy further, please click here for the calendar of the upcoming online classes. For a free PowerRatings trial, click here. If you have any questions on the research or the strategy please feel free to email us at editor@tradingmarkets.com or call 213-955-5858 ext 1.

Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.

Ashton Dorkins is Editor-in-Chief of TradingMarkets.com.