Technical Trading

Can pattern recognition software, combined with news sentiment, identify profitable short-term stock trades? In their July 2024 paper entitled “Technical Patterns and News Sentiment in Stock Markets”, Markus Leippold, Qian Wang and Min Yang test the ability of pattern recognition software (convolutional neural network) to find profitable technical reversal patterns within U.S. and Chinese stock candlestick charts. They consider four pairs of technical patterns: double tops and bottoms; head and shoulders and inverted head and shoulders; broadening tops and bottoms; and, triangle tops and bottoms. They use Bollinger bands to find local maximums and minimums, with the standard deviation multiplier set at 1.1 based on parameter tuning. They augment pattern recognition with news sentiment from Refinitiv for U.S. stocks since 2003 and from Tonglian for Chinese stocks since 2014 during the 10 trading days around each pattern. They identify combined tops as double tops, head and shoulders, broadening tops or triangle tops coupled with negative news and combined bottoms as double bottoms, inverted head and shoulders, broadening bottoms or triangle bottoms coupled with positive news. They first consider each technical pattern as an independent event and measure abnormal returns for holding intervals of 1, 5, 10, 21 and 42 days after a signal. They then examine the performance of a portfolio of events for a 1-day holding interval. They use U.S. stock data from 1992 to 1999, enhanced via two data augmentation strategies, for pattern recognition software training and validation. They then apply the trained software to U.S. stock data from 2000 through 2021 and Chinese stock data from 2005 through 2021. Combined pattern-sentiment test periods are shorter based on availability of sentiment data. Using price series for all U.S. common stocks and Chinese A-shares and news sentiment data as described through 2021, they find that: Keep Reading

Can investors manage cryptocurrency volatility risk with simple trend following rules? In their August 2024 paper entitled “Trend-following Strategies for Crypto Investors”, Trinh Hue Le and Ummul Ruthbah test simple trend following rules on Bitcoin (BTC), Ether (ETH) and the S&P Cryptocurrency LargeCap-Ex. MegaCap Index. Specifically, they hold the cryptocurrency (cash) when its price is above (at of below) its prior-day simple moving average (SMA) of 20, 65, 150 or 200 days. To assess net profitability, they consider trading frictions of 0.1%, 0.25% or 0.5% of amount traded. They further measure correlations between the movements of cryptocurrencies and those of the Nasdaq 100 Index. Using daily prices for the S&P BTC, ETH and Cryptocurrency LargeCap-Ex. MegaCap indexes starting January 2016, January 2017 and January 2019, respectively, all through January 2023, and contemporaneous daily levels of the NASDAQ 100 Index, they find that:

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Does subjective technical analysis truly add value? In their June 2024 paper entitled “The Power Of Price Action Reading”, Carlo Zarattini and Marios Stamatoudis investigate the value added to simple trading rules by the discretionary judgments of an experienced technician for a sample of stocks with: (1) overnight gaps up over 6%; (2) minimum opening price $2.00; and, (3) minimum pre-market volume at least 200,000 shares. One of the paper’s authors (Marios Stamatoudis) is the expert technician. They assess his abilities both to select the best gaps to trade and to micromanage precise entry points, stop-losses and partial exits at predetermined profit points. To screen out confounding information, they remove dates, ticker symbols, sectors/industries, news, and specific prices/volumes from the his inputs, leaving only an anonymized visual 2-year daily price history for each stock. They present gaps to him randomly, not in chronological order. Using daily pre-gap prices and 1-minute post-gap prices for NYSE and NASDAQ stocks satisfying the above three criteria during January 2016 through December 2023 (9,794 events), they find that:

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A subscriber suggested review of the February 2017 paper “Bubbles for Fama”, in which Robin Greenwood, Andrei Shleifer and Yang You assess Eugene Fama’s claim that stock prices do not exhibit bubbles. They define a bubble candidate as a value-weighted U.S. industry or international sector that rises over 100% in both raw and net of market returns over the prior two years, as well as 50% or more raw return over the prior five years. They define a crash as a 40% drawdown within a two-year interval. They also look at characteristics of industry/sector portfolios identified bubble candidates, including level and change in volatility, level and change in turnover, firm age, return on new versus old companies, stock issuance, book-to-market ratio, sales growth, price-earnings ratio and price acceleration (abruptness of price run-up). They evaluate timing strategies that switch from an industry portfolio to either the market portfolio or cash (with risk-free yield) based on a price run-up signal, or a signal that combines price run-up and other characteristics. Their benchmark is buying and holding the industry portfolio. Using value-weighted returns for 48 U.S. industries (based on SIC code) during January 1926 through March 2014 and for 11 international sectors (based on GICS codes) during October 1985 through December 2014, they find that:

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A subscriber asked for confirmation that the strategy described at “Meb Faber’s 12-Month High Switch” (the strategy) is attractive. This strategy at each monthly close:

• Calculates the 12-month high for: SPDR S&P 500 ETF Trust (SPY), iShares MSCI EAFE ETF (EFA), Vanguard Real Estate Index Fund ETF Shares (VNQ), SPDR Gold Shares (GLD) and Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC) based on dividend-adjusted prices.
• Allocates 20% of the portfolio to each asset currently within 5% of its 12-month high.
• Allocates any remaining funds to iShares 7-10 Year Treasury Bond ETF (IEF) if IEF is within 5% of its 12-month high, or otherwise to cash with return estimated by the yield on 3-month U.S. Treasury bills (T-bill).
• Rebalances to equal weights each month and applies trading frictions of 0.1% per 1-way trade for any switches in holdings.

To investigate, we replicate the strategy, substituting Invesco DB Commodity Index Tracking Fund (DBC) for PDBC to get a longer sample period that includes the 2008-2009 financial crisis. We use an equal-weighted (EW), monthly rebalanced combination of SPY, EFA, VNQ, GLD and DBC as a benchmark. We apply 0.1% frictions to ETF switches but not to simple rebalances, which are generally small. Using monthly dividend-adjusted prices for SPY, EFA, VNQ, GLD and DBC during February 2006 (DBC inception) through June 2024, we find that: Keep Reading

Is industry trend-following an attractive strategy over the long run? In their June 2024 paper entitled “A Century of Profitable Industry Trends”, Carlo Zarattini and Gary Antonacci evaluate the long-term performance of a long-only industry trend-following (Timing Industry) strategy, modeled as follows:

• Entry – buy an industry when its daily closing price crosses above the upper band of either its 20-day Keltner Channel (with a multiplier of 2 for the high-low price range component) or its 20-day Donchian Channel.
• Sizing – each day for each open position, calculate 14-day past return volatility as an estimate of its future volatility and resize all open positions so that they contribute equally to overall portfolio volatility, limiting overall portfolio leverage to 200%.
• Exit – each day for each open position, close the position if it crosses below a stop loss represented by the lower band of either its 40-day Keltner Channel (again with a multiplier of 2 for the high-low price range component) or its 40-day Donchian Channel. However, do not ever lower the stop loss. When a position closes, reinvest proceeds into 1-month U.S. Treasury bills.

For a long-term test, they apply these rules to nearly 98 years of daily returns for 48 hypothetical annually rebalanced, capitalization-weighted industry portfolios constructed by assigning a Standard Industrial Classification (SIC) Code to each stock traded on NYSE, AMEX and NASDAQ. For a recent and more realistic test, they apply these rules to 31 sector exchange-traded funds (ETF) offered by State Street Global Advisors. Utilizing daily returns for the 48 industry portfolios since July 1926 and for the 31 sector ETFs as available (inceptions January 2005 to June 2018), all through March 2024, they find that:

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Is the Buffett Indicator, the ratio of total U.S. stock market capitalization (proxied by Wilshire 5000 Total Market Index W5000) to U.S. Gross Domestic Product (GDP), a useful indicator of future U.S. stock market performance? W5000/GDP clearly has no stable average value over its available history (see the first chart below), so the level of the ratio is not a useful predictor. We therefore consider the following variables based on W5000/GDP as predictors of W5000 returns at horizons up to two years:

1. Quarterly change in W5000/GDP.
2. Average quarterly change in W5000/GDP over the past two years (eight quarters).
3. Average quarterly change in W5000/GDP over the past five years (20 quarters).
4. Slope of W5000/GDP over the past two years.
5. Slope of W5000/GDP over the past five years.

We consider two kinds of tests: (1) a linear test relating past changes in these variables to future W5000 returns up to two years; and, (2) a non-linear test calculating average next-quarter W5000 returns by ranked fifths (quintiles) of past changes in these variables. Using quarterly levels of W5000 (with extension), Shiller’s P/E10 lagged by one quarter and quarterly GDP lagged by one quarter during the first quarter of 1971 through the first quarter of 2024, we find that: Keep Reading

Is momentum better measured by a granular fitted line or beginning-to-end return? In their March 2024 paper entitled “Trended Momentum”, Charlie Cai, Peng Li and Kevin Keasey investigate use of an analytically/visually clear linear stock price trend to enhance conventional momentum. They measure price trend clarity (TC) as R-squared for a regression of daily price versus date over the past 12 months. Specifically, they each month:

• Sort stocks into fifths (quintiles) based on conventional momentum, return from 12 months ago to one month ago.
• Further sort the top momentum quintile into finer quintiles based on TC.
• Form  equal-weighted or value-weighted portfolios of resulting sorts and compute their gross returns and 3-factor (market, size, book-to-market) alphas over the next six months.

To confirm use of TC to measure clarity of price trend, they separately conduct an experiment that relates analytical TC to trend clarity perceived by sample of 128 individuals each evaluating 10 pairs of stock charts. Their sample includes daily price data for U.S. common stocks from January 1927 through December 2020. Analyses requiring earnings start in 1964, while those involving investor sentiment span 1967 through 2018. They groom all variables to exclude outliers. In further analyses, they employ global stock price data. Using the specified methodology and data, they find that:

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Can day traders get rich with an Opening Range Breakout (ORB) strategy that buys (sells) unusually active stocks with positive (negative) opens that break out to new highs (lows) during the first five minutes of the trading day? In their February 2024 paper entitled “A Profitable Day Trading Strategy For The U.S. Equity Market”, Carlo Zarattini, Andrea Barbon and Andrew Aziz test a 5-minute ORB applied to stocks with unusually high daily trading volume (Stocks in Play). Rules for this strategy start with screening listed U.S. stocks for:

1. Opening price above $5.
2. Average daily trading volume at least 1,000,000 shares during the last 14 trading days.
3. Average True Range (ATR) over the last 14 days more than $0.50.
4. Opening range interval volume relative to the last 14 days (Relative Volume) at least 100% and among the 20 with the highest Relative Volumes.

Each day for each stock surviving this screen, they place a stop order to buy (sell) if the stock moves up (down) in the first five minutes and then again reaches the high (low) of this range after the first five minutes. For each executed trade, they set a stop-loss order at 10% ATR distance from the executed entry price. If the stop loss does not trigger intraday, they close the trade at the market close. They size each trade such that the loss on a triggered stop-loss would be 1% of capital deployed and impose a 4X leverage constraint. They assume $25,000 starting capital and impose $0.0035 per share commission (per Interactive Brokers Pro Tiered as of December 31, 2023). Using the specified data for all U.S.-listed stocks (over 7,000) during January 2016 through December 2023, they find that:

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“Turn-of-the-Month Effect Persistence and Robustness” indicates that average absolute returns during the turn-of-the-month (TOTM) are strong for both bull and bear markets. Does a strategy of capturing all bull market returns and TOTM returns only during bear markets perform well? To investigate, we apply four strategies to SPDR S&P 500 ETF Trust (SPY) as a tradable proxy for the stock market:

1. SPY – buy and hold SPY.
2. SMA200 – hold SPY (cash) when SPY closes above (below) its 200-day simple moving average (SMA200) the prior day.
3. TOTM – hold SPY from the close five trading days before through the close four trading days after the last trading day of each month and cash at all other times (TOTM).
4. SMA200 or TOTM – hold SPY when SPY closes above its 200-day SMA the prior day and otherwise use the TOTM strategy.

We explore sensitivities of these strategies to a range of one-way SPY-cash switching frictions, with baseline 0.1%. Using daily dividend-adjusted SPY from the end of January 1993 through early January 2024 and contemporaneous 3-month Treasury bill (T-bill) yields as the return on cash, we find that: Keep Reading