The trading pattern my firm will discuss here is inspired by a book with a remarkably cheesy title: Trading Secrets of the Inner Circle
by Andrew Goodwin. The book is divided into brief chapters, and each chapter outlines a specific trading pattern based upon open, high, low, and close (OHLC) data. I read this book years ago when I was first learning about pattern-based trading. After reading this book, I went through each chapter and backtested every single pattern that the book outlines. My findings were that most all of the patterns were (at the time I evaluated them) utterly useless. However, I did learn some very important concepts from this exercise, and discovered a few patterns that -- so far -- have had serious staying-power.
The pattern we will be evaluating is a concept called “Turnaround Tuesday,” which is a pattern that reflects the stock market's inordinate tendency to experience price reversals on Tuesday. This pattern is hardly a well kept secret. Indeed, I have seen it discussed on a number of blogs over the years, and I myself have used it as a trading factor in stock indexes for around 10 years.
Let’s evaluate a specific variation of this pattern that includes both “buying on a dip” and the Turnaround Tuesday factor. We will be using S&P 500
(INDEXSP:.INX) stock index futures data; however, the idea is also directly applicable to the SPDR S&P 500 ETF
We will define a “dip” as a close on Monday that occurs in the bottom 20% of the three-day trading range. Here is a graphical representation of this concept:
The exact rules we will be evaluating are:
Monday closes in the bottom 20% of the three-day range.
On Tuesday, buy on the open.
Sell on the close of Wednesday.
Here are the results of the of the Turnaround Tuesday system compared to the return of using the same strategy but with different days of the week being used as the trading signal:
Based on this data, it appears that the Turnaround Tuesday pattern has continued to have merit. It can be difficult to present a visual depiction of performance when using futures contracts because of the leverage inherent in these markets. To get around this, I am presenting a graph of the compounded return on the notional value of the contract (the underlying contract value, which in the S&P 500 contract is 50 times the index price). The Turnaround Tuesday idea is in the market only 4% of the time and is not intended as a stand-alone system.
If you have found this study interesting, I have posted an additional study here
. We look at buying after the Turnaround Tuesday pattern sets up on a dip below the open and on an intraday breakout above the open. By the way, when I post this type of study I often get comments and questions about my method for evaluating trading strategies. Almost everything I care to say on this topic can be found here
Nat Stewart runs the trading-strategy website www.nastrading.com. The site’s mission: “Help traders capture explosive moves in the forex, futures, and stock markets.”
No positions in stocks mentioned.