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A Consistently Successful Signal

By think you're the only one that sees that?!


I don't pay very much attention to most technical indicators.

I have charts that I consult on a regular basis with several common indicators, not necessarily because I use them for decisions but because so many others look at them, and I want to see what everyone else sees.

Paging through my charts this morning, I noticed something interesting. On a weekly chart of the S&P 500, the stochastic indicator I use (with a 21, 3, 3 setting) just had a bullish cross where the faster average crossed above the slower average, all while both were below the "oversold" level of 30. This struck my interest because the S&P is trading above its long-term 50-week moving average. None of the parameters were optimized, they are standard settings I use on all time frames.

This is one definition of "oversold in an uptrend". It doesn't much matter how you define it, as long as you do it consistently, but buying oversold conditions in an uptrend and shorting overbought conditions in a downtrend tend to be consistently successful (in all time frames). Not 100%, but probably as close as you're going to get. Of course, the trick is figuring out the definitions of "overbought/oversold" and "trend".

I wanted to check other times in history (back to 1950) that the S&P showed similar characteristics to now - a stochastic cross while in oversold territory while the index was still trading above its 50-week average.

Two weeks later, the S&P was higher 13 out of 17 times, with an average return of +1.1%. Four weeks later, it was higher 14 of 17 times with an average return of +2.4%.

The three losses were -0.8%, -3.5% and -0.2%. Overall, the average loss was -1.5% while the average gain was +3.2%. The last 10 trades, going back to 1979, were all winning trades if held for four weeks. In the period from 1969 - 1979, the one many are comparing to the potential we're seeing now, there were 7 trades, 5 successful, with an average 4-week return of +1.3%.

So, we show 82% winning trades, minimal drawdowns, and winning trades that were twice as large on average as the losing trades. Sounds pretty good to me.

Would I recommend a trade based on this? Nah...first, I used only Friday-to-Friday closes, so using other days might change the results. Someone else might also come up with different values for the stochastic readings. I do everything manually using Excel, so there's always the potential that I fat-fingered a figure or two. And we run the risk that the stochastics pretzel-twist, staying in oversold for weeks on end as the market sells off. Figuring out if that is likely or not is the key.

I'm not sure how robust this would be if you tried to use it as a very simple trading system. But I thought it was a consistent enough phenomenon to note that it could perhaps serve as a jumping-off point for further research. I don't care much for theoreticals - I want practical data that will make me money...crass, but it's the only reason for putting capital at risk. It doesn't get much simpler than this, but if it's practical, and it's consistent, then it gets my attention.

No positions in stocks mentioned.

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