Managing Your Money in Rising Markets with The Machine
In my previous post, we discussed the fact that markets go up, markets go down, and markets go sideways. Today let’s look at how to proactively take advantage of the times when markets are rising.
In The Machine we have four separate categories, which allow you to have long positions when the markets rise. Two are short term categories and two are longer term trend following categories.
The two short term categories are mean reversion in Stocks, and mean reversion in ETFs. Each of these categories have individual strategies to take advantage of the times when markets become oversold compared to their historical daily levels. Each take advantage of the quantified fact that markets above their 200-day moving average have historically risen after they have pulled back to more extreme levels.
Today we’ll look at the equity, short term, long mean reversion strategies.
Within The Machine, we have 10 separate strategies that have over 11,000 variations from which you can choose (more strategies will be added in the near future including the historically high performing Long Pullbacks V2 Strategy). Even though there are many thousands of variations for you to choose from, (which by the way allows you to put your mind to ease about how robust these strategies are), you can sort each strategy by a number of separate metrics including its Compounded Annual Growth Rate (CAGR), Sharpe Ratio, Historical % Correct and a number of other metrics.
Every strategy (as of January 2011) has the exact same philosophy, which we have been publishing for more than 1 ½ decades. The key rules are:
- The stocks are in longer term up-trends above their 200-day ma.
- They have recently pulled back significantly.
- They have pulled back even further today triggering a buy signal.
- They are sold into strength above their 5-day moving average or above a 2-period RSI reading above 70 (unless you elect to choose a strategy with a stop).
These four rules combined have consistently shown historically above average edges since 1989. The Machine displays data starting from 2001, but we have internal studies going back over two decades showing the same behavior. During this period of time there have been wars, multiple presidents, an internet boom/bust/boom, a major credit expansion followed by a major credit crisis, along with dozens of other major political and economic events. Yet these strategies have consistently performed year after year, better than any other trading philosophy that has been published.
I know you are likely using the equity mean reversion strategies as they are the backbone of The Machine. I’ll add a few additional guidelines for you consider for your portfolio.
- The Long Pullbacks strategy has the highest CAGR. The new Long Pullbacks V2, coming soon, has even higher average yearly returns. Long Pullbacks are one of my favorite strategies and many traders use it. If you decide it belongs in your portfolio, don’t only look at CAGR; look at the Sharpe Ratio also to identify good past performing variations.
- When you build a portfolio, you may want to look at the level of pullbacks and blend them. This means using one strategy to take advantage of shallow pullbacks, a second to identify mid-level pullbacks and a third to identify deep pullbacks. There are a number of ways to do this, but the simplest way is to look at the level of the limit order entry. 2-4% for shallow pullbacks, 6% for mid-level pullbacks and 10% limits for deeper pullbacks. This blend allows you to apply a balanced approach to your short term, mean reversion equity strategies.
- Because there are so many thousands of variations available to you, select ones that other people will likely not be trading. The reason is that The Machine licensee base is growing almost daily and it’s very easy for someone to simply build a portfolio using highest CAGR or highest Sharpe. This is not necessary the best way, and it will potentially lead to crowding in the set-ups around those variations.
Go deeper into the selection, meaning not using the #1 or #2 historically best performing variations. We’ve built portfolios using the 100th best variations for Sharpe with combined strategies and the test results were solid. Few if anyone else will be selecting variations that deep, and that means there will be little competition for fills at those levels. You don’t need to go all the way to #100. The point is that The Machine is deep and as more people license it may be best to find variations and strategies that few others are likely using.
I hope these guidelines are helpful to you. Using the Strategy Selector to guide you is also another way to do this and many people told me it has tremendously helped them build a historically high performing portfolio that is correct for them.
In my next post, I’ll share with you how to add short term, mean reversion strategies with ETFs to your portfolio.
Enjoy the holidays!
Larry Connors is founder and CEO of TradingMarkets.com and Connors Research
Markets only move in three directions: up, down and side to side. Click here to learn why combining quantified mean reversion (pullback) strategies with quantified trend following strategies can be an excellent way for traders and investors to manage and grow their money in any market environment.
And then click here to save your spot at the next free, all-questions-answered webinar presentation by Larry Connors: Building a Balanced, High Performing Portfolio with The Machine.