High Probability ETF Trading: 3-Day High/Low Method

High Probability ETF Trading: 3-day High/Low Method
  • Clearly Described Trading Strategies
  • Verifiable Statistical Edge
  • Easy to Read
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5

Summary

High Probability ETF Trading: 7 Professional Strategies to Improve Your ETF Trading was published in 2009. The clearly defined and quantified strategies contained within this book are a fertile playground of trading discovery.

In a world where financial ideas are quick to stale–the strategies contained within this book have stood the test of time.

Today’s article is an overview of the book, and the first of several blog posts. Where I will be testing and writing about each strategy in high detail. Today, we are going to explore the 3-day High/Low Method.

Nearly all trading related books are a horrible waste of time and money. This book is not. This book should be part of the foundation in which to build your trading career upon.

Highly recommended. And it’s dirt cheap.

Thanks for reading today’s review of High Probability ETF Trading: 7 Professional Strategies to Improve Your EFT Trading

I have a confession. I am a sucker for trading books. They say that “You should never judge a book by its cover.” Yet this is exactly what I do.

And I cannot stop myself. The more pretty the cover, the higher the likelihood that I will furiously jab the ‘Buy Button.’

Patiently I wait for the book to arrive in the mail. It does. And then I excitedly begin reading the pages. Hoping to find the ‘holy grail’ of trading. I never do.

Most Trading Books Suck

The hard and cold truth about trading books…nearly all of them are terrible. And I mean 99.99% are just horrible. In fact, sometimes I cry tears of pain because a poor tree had to sacrifice itself to provide a canvas on which to print upon.

What about returning the trading book to the book store? Or mailing it back to Amazon? Ditto. Who has the time for that?

Another problem with trading books in the modern age is that most are now delivered digitally. So once you download the book, you are now the irrevocable owner. What a pain.

Some Trading Books are Good

Some trading books are actually quite good. Foundational. But they are very rare.

What makes a great trading book? In my opinion, an excellent trading book contains the following:

  • A set of clearly defined strategies with exact rules that can be backtested.
  • Less trading ‘truisms’ and Woulda-Coulda-Shoulda chart examples.
  • No fancy mathematics or complicated formulas that confuse and imply “I am smart, and you are not.”
  • No upsell. In other words, the book is not ‘bait’ to purchase yet more expensive products or services.

Today, I want to talk about a book that was published in 2009. I purchased the book in 2010. It’s a beauty. A foundational type book.

The name of the book is High Probability ETF Trading: 7 Professional Strategies to Improve Your ETF Trading. The author of the book is Larry Connors and Cesar Alvarez.

High Probability ETF Trading

Before we go any further, I want to notify that audience that I have include an Amazon affiliate link. The cost of the book is $9.99 with Kindle or $29.99 hardback. If you purchase this book through Amazon, I will earn 30 cents. Yes, the grand sum of 30 cents. Just wanted everyone to understand that I am in for a huge payday. Okay, got that out of the way, let’s get started on this…

A foundational type book

The book is only about 120 pages in length. A short book. However, it is rich in robust trading strategies. There are 7 complete strategies that needed to be hand-coded and tested. And each strategy needed to be tested on a portfolio of Exchange Traded Funds in various asset classes. Yes, it was time-consuming.

If I were to write a single blog post on this book, and included all 7 strategies, then the blog post would easily be 20k to 30k words in length. Far to much content for a simple book review. In fact, it would be longer than the book itself.

So, I am going to break the book into several blog posts that talk about each strategy and also reveal the individual performance.

I want you to think about this book as a foundation. Something that will serve as a launch pad for your own research. I truly believe that this book, if properly consumed will put you light years ahead of your competition.

Why Exchange Traded Funds?

This book was originally published in 2009, and it talked about the rapidly growing universe of ETF’s or Exchange Traded Funds.

Since the publishing of this book, the ETF universe has exploded in size and complexity. There is an ETF available for just about every possible investment niche. Even the transgender have their own ETF!

Probably the most recognizable and popular ETF is the SPY which is currently commanding (August 2017) about 63 million shares traded daily. A big, deep, and wide market.

What exactly is an ETF? Essentially, it is a basket of stocks grouped together into a common theme. For instance, the SPY ETF can be purchased as a single share. Each SPY ETF share contains a tiny portion of every stock contained within the SP500.

There are several other advantages of trading ETF’s which include:

  • Safer than individual stocks. Ever been on the wrong side of a fraudulent corporate earnings report? Chief Executive Officer caught in bed with a prostitute–a male prostitute? Then you know what I am talking about! (Enron 2001)
  • ETF’s can be traded on both the long side and the short side.
  • ETF’s can be traded with leverage or without leverage.

In a nutshell, an EFT provides protection from corporate risk. If a single stock within the ETF plunges due to fraud or poor earnings, then the related basket of stocks within the ETF will help to soften the blow.

Portfolio of ETF’s

In the book: High Probability ETF Trading: 7 Professional Strategies to Improve Your ETF Trading, the authors of the book used a basket of 20 highly diversified ETF’s. The ETF universe of 2008 is hardly recognizable to the 2017 ETF universe.

However, to keep the spirit of the book intact, we are going to keep the original portfolio for testing purposes. The advantage is that we can see just how well everything has performed since the publishing of the book.

The following table is the complete list of ETF’s. I have also included an outgoing link that gives a highly detailed explanation of the ETF, directly from the ETF provider.

 

Symbol Linked to Complete Description Quick Description
DIA Diamonds Trust The Dow Jones Industrial AverageSM (DJIA) is composed of 30 “blue-chip” U.S. stocks.
EEM iShares Emerging Markets Exposure to large and mid-sized companies in emerging markets.
EFA iShares MSCI EAFE Exposure to a broad range of companies in Europe, Australia, Asia, and the Far East.
EWH iShares Hong Kong Exposure to large and mid-sized companies in Hong Kong.
EWJ iShares Japan Exposure to large and mid-sized companies in Japan.
EWT iShares Taiwan Exposure to large and mid-sized companies in Taiwan.
EWZ iShares Brazil Exposure to large and mid-sized companies in Brazil.
FXI iShares China Exposure to large and mid-sized companies in China.
GLD SPDR Gold Shares The first US traded gold ETF and the first US-listed ETF backed by a physical asset.
ILF iShares Latin America Exposure to large, established companies in Latin America.
IWM iShares Russell 2000 Exposure to small public U.S. companies.
IYR iShares Dow US Real Estate Exposure to U.S. real estate companies and REITs, which invest in real estate directly and trade like stocks.
QQQ PowerShares NASDAQ 100 Exposure to largest non-financial stocks on Nasdaq.
SPY SPDR SP500 The S&P 500 Index is a diversifed large cap U.S. index that holds companies across all eleven GICS sectors.
XHB SPDR SP500 Home Builders Exposure to home building products and producers.
XLB SPDR Materials Exposure to materials producers: chemical, construction, packaging, mining, paper, etc.
XLE SPDR Energy Sector Exposure to the energy sector of the SP500.
XLF SPDR Financial Sector Exposure to insurance, banks, thrifts, RE trusts, mortgage finance, consumer finance of SP500.
XLI SPDR Industrial Exposure to defense, aerospace, marine, machinery, airlines and air freight.
XLV SPDR Health Care Exposure to pharmaceuticals, health care equipment, health care related produces and services.

As you can see, this list of ETF’s encompasses a broad spectrum of asset classes and locales. If something is moving on planet earth, this list of ETF’s should catch the move.

Ok, so now we know the portfolio of ETF’s that we will be testing, let’s move on to Strategy A of the book.

Strategy A: The 3-Day High/Low Method

The following are the exact rules, for the long side only.

  1. Today the ETF is above the 200-day moving average.
  2. Today the ETF closes below its 5-day moving average.
  3. Two days ago the high and low price of the day is below the previous day’s high and low.
  4. Yesterday the high and low price of the day is below the previous day.
  5. Today’s high and low price is below yesterday’s.
  6. Buy on the close today.
  7. Exit on close when the ETF closes above its 5-day simple moving average.

You may look at this list of rules and be thinking, “wow this sure seems complicated.” But it’s not. It is actually a very simple daily bar pattern. Below, I  have included a screen capture of what the pattern looks like:

What a stupid simple pattern. You are simply looking for the 3-bar pattern. Entering on the close. Exiting at a close above the 5-day moving average.

The following results assume that a person invests $2,000 per trade.

3-day high low equity curve

Looking at this equity curve, you should notice two things:

  • The book was published in 2009. No changes have been made to the original strategy or portfolio, yet it continues to generate robust profits.
  • The big drawdown in 2011 was the Chinese stock market crash, which caused massive panic globally, yet the strategy continued to grind higher.

Now let’s dig deeper into the data and review the individual performance of each ETF:

3-Day HighLowResults

Ok, now lets look at the short side.

The short side rules are the exact opposite of the long side rules.

The following are the exact rules, for the short side only.

  1. Today the ETF is below the 200-day moving average.
  2. Today the ETF closes above its 5-day moving average.
  3. Two days ago the high and low price of the day is above the previous day’s high and low.
  4. Yesterday the high and low price of the day is above the previous day.
  5. Today’s high and low price is above yesterday’s.
  6. Sell on the close today.
  7. Exit on close when the ETF closes below its 5-day simple moving average.

The following results assume that a person invests $2,000 per trade.

3-Day HighLowSell

Some readers might be looking at this equity curve and thing to themselves, “Oh this is jagged and not very pretty.” For that I say…you are CRAZY! The truth is that this method has done a wonderful job at catching every market plunge. It caught the 2007-2008 housing crisis, it caught 2011 Chinese stock market crash, and it caught the deep pullback in 2015.

Now let’s dig deeper into the data and review the individual performance of each ETF:

3-Day HighLowSellresults

Shorting the stock market has generally been a game for suckers. Nearly all global stock markets, over the long term, have continued to grind higher. Whenever you can find something that does a decent job of catching the sell offs, then you really need to take notice. I sure do. To me, the short side equity curve and performance table look beautiful. When the next market bust hits…I will be expecting a fast payday from this strategy.

Combining Long and Short with minimal risk.

Both the long side test, and the short side test assumed a minimal $2,000 investment. I purposely kept the amounts very small. Most TradingSchools.Org readers are playing with very small trading accounts. Typically, they will attempt to ‘day trade’ their small amount into a large amount, in a very short period of time. Nearly all will fail. Day trading is pretty much a death trap for newbies.

However, the 3-Day High/Low method is really a great option for small trading accounts. The typical losing trade is usually less than $50. So you can get your feet wet, without putting your life at risk.

Another advantage is that you don’t really need any fancy or expensive trading software to execute and trade this method. Once you internalize what the pattern looks like, you can visually scan a chart in a few seconds looking for the setup.

Yet another advantage is that you don’t need to be glued to a trading screen all day. Since all of the entries and exits occur on the close, then you typically need to check for entries and exits about 20 minutes before the stock market closes. Simple and stress-free.

Wrapping Things Up

In the following blog posts, I will be introducing yet more of the strategies contained within this excellent book. As good as these strategies are…this isn’t really where the magic happens.

The real magic is when you take these strategies and add the element of your own unique imagination. There are hundreds of portfolio combinations and minor permutations that can be applied. I love volatility filters. Without giving away the store, I can assure you that adding a volatility filter will supercharge the results–but you need to do the work.

If are interested in having this strategy, or any other strategy that I write about coded and ready to deploy, then simply download a free copy of Trade Navigator. I will forward the strategies to your inbox, simply import and away you go.

Thanks for reading. Quite a long blog post. Congratulations for stumbling through my poorly written article.

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