Thursday, October 27, 2016 10:09:29 AM
Pattern Trading versus Mean-Reversion Systems by ART HILL
And now for the biggest conundrum of all! Actually, there is no conundrum if you already have a strategy and you are trading according to that strategy. This is why it is of the utmost importance to plan your trade before making the trade and then trade that plan. No ifs, ands or buts. The broad market environment remains bullish and SPY is in a long-term uptrend, but small-caps are dragging their feet as IWM broke flag support on Wednesday. This is negative for pattern traders and I am marking first resistance at 122. A recovery and breakout here would put small-caps back on the bullish track.
Mean-reversion traders will notice that RSI(5) moved below 30 to set up another mean-reversion trade. This is the second double-dip in the last six months. Notice that RSI(5) also did the double-dip in May and June. These double-dips were challenging because IWM broke support each time. And then rallied. This system does not use a stop-loss and instead exits when RSI(5) moves above 70. Obviously, this is not going to happen in the next day or two, but it does not take much to push 5-day RSI to its extremes. A 4-7% surge often does the trick. This does, however, mean that IWM could decline further and RSI(5) will not trigger an exit until the next bounce. For example, IWM could decline to 117 and then bounce above 122 to trigger an exit. This would also trigger a breakout on the price chart. See the conundrum between the two strategies? Visual pattern trading says one thing when quant driven mean-reversion trading says another.
And now for the biggest conundrum of all! Actually, there is no conundrum if you already have a strategy and you are trading according to that strategy. This is why it is of the utmost importance to plan your trade before making the trade and then trade that plan. No ifs, ands or buts. The broad market environment remains bullish and SPY is in a long-term uptrend, but small-caps are dragging their feet as IWM broke flag support on Wednesday. This is negative for pattern traders and I am marking first resistance at 122. A recovery and breakout here would put small-caps back on the bullish track.
Mean-reversion traders will notice that RSI(5) moved below 30 to set up another mean-reversion trade. This is the second double-dip in the last six months. Notice that RSI(5) also did the double-dip in May and June. These double-dips were challenging because IWM broke support each time. And then rallied. This system does not use a stop-loss and instead exits when RSI(5) moves above 70. Obviously, this is not going to happen in the next day or two, but it does not take much to push 5-day RSI to its extremes. A 4-7% surge often does the trick. This does, however, mean that IWM could decline further and RSI(5) will not trigger an exit until the next bounce. For example, IWM could decline to 117 and then bounce above 122 to trigger an exit. This would also trigger a breakout on the price chart. See the conundrum between the two strategies? Visual pattern trading says one thing when quant driven mean-reversion trading says another.
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