Trade Aggressively When You Have the Edge

In today’s trade example, I am going to look at the most recent trade sequence.  Before I get started, I want to highlight on the chart where this sequence fits in the bigger picture. At point 1 labeled on the chart we show the last sell off which kicked off on February 27th (we wrote about this past trade sequence 2 weeks ago). At point 2 on the chart we show the mean-reverting bounce back which led to our exit signal. After our exit signal, which is labeled as bar 3, the market goes sideways for 2 additional days. This sets up our next trade sequence which begins on March 13th.

At bar 4 we get a big sell off that triggers four of the TradingMarkets Market Timing buy strategies. I wanted to play these buy signals aggressively since several of them triggered (4) and because of the magnitude of the sell off. These are two of the four criteria I use to judge how aggressively I want to trade particular buy or sell signals. In this case, the sell off was deep which answers the first question I always ask when a buy strategy is triggered. “Has the market made a move up or down that is big enough for there to be a mean-reverting move back in the other direction?”  In other words, is this move down big enough that there is something to reverse? Also, our research shows that the more CRG buy signals that trigger on any one day, the higher the probability there is for a successful trade.

In this trade I opted to buy the SPY ETF because time premiums on the SPY calls were expensive. When buy strategies are triggered, I look to buy the market using the SPY ETF, E-mini S&P futures or deep in-the-money calls. I bought two positions of the SPY at 138.23 at the close. (I break my trading account into 5 different position sizes and allocate the positions according to the signals that are triggered. I buy on the close of the day the actual signals are triggered).  The following day, we see a greater sell off labeled as bar 5. This day was very volatile, with the market trading to new lows and then recovering at the end of the day to close positively. We got 3 more buy signals triggering on this day, and we bought one more position size at 139.20 for a total of three position sizes at an average cost of 138.55. I was less aggressive on buying my position size on bar 5 because it had rallied quite a distance from its low by the time it closed.

With the recent spike in volatility in the market, I was prepared to save some of my allocations if the market gave me additional buy signals. The market then meanders for two more days without triggering any additional buy signals and then moves up to the point where we get our exit signal at bar 6 (140.20 on the SPY). So this last sequence we made 1.65 SPY points while only being in the market for four days. This is a perfect example of how we at TradingMarkets look to buy weakness and take advantage of the mean-reverting properties in the market. Again, we statistically quantify certain behavioral patterns that occur over and over again in the markets, and look for specific edges that give us high probability trades. In this trade example, we clearly see the extreme stretch from the mean that bar 4 and 5 creates. This extreme works its way out in the next few days by a mean reversion which occurs at bar 6.

Paul Sabo has been a professional trader for over 18 years. During this time he has worked as a market maker in both New York City and San Francisco for some of Wall Street's most prestigious investment banks, commercial banks and brokerage houses. Paul later became the head trader for a top-ranked investment advisor and hedge fund based in San Francisco. Paul recently left his position at the hedge fund to trade his own money as a full time business as well as working with Connors Research Group on various proprietary projects.

Learn more about the 200-day moving average in the "TradingMarkets S&P Market Timing Course". To listen to a free Market Timing presentation led by Paul Sabo and Larry Connors, click here.