Sunday, September 03, 2006

Buy the Dips Sell the Rips

Just for fun I back-tested two filters against two separate date ranges - one range where I knew that the market went up and one where I knew that the market went down. The two periods were July 17 through July 28 and June 2 through June 14 respectively. The reason why the periods are unequal in length is that the down period is contiguously down i.e. every day closed lower than the day before while the up period had two down closes in it. So by lengthening the up period to include eight up closes I think they are roughly equal.

The filters were simple – close between 15 and 50, average 90 day volume greater than 500000 and for one – the close was more than 75 cents greater than the open and for the other - the close was more than 75 cents lower than the open. That is – the two filters were exactly opposite in nature on a single day.

The results will amaze and astound you – or maybe not but pay attention anyway. For the up-going period the 75-cent gainer found 150 completed trades. Of these 54% resulted in a net gain. The annualized return on investment (ROI) was –14.81%. That is while the filter found more winners than losers overall it lost money. On the other hand the 75-cent loser found 102 completed trades. Of these 57% resulted in a net gain and the ROI was plus 55%. This proves that in an up going market buying the dips is more profitable than following the money.

But - what about a down going market? Glad you asked.

The 75-cent gainers found 65 completed trades that resulted in a 28% net gain and an ROI of –355%. The 75-cent losers found 100 completed trades that resulted in a 16% net gain and an ROI of –450%. So in a down going market the gainers do better than the losers but both come out to be large losers.

But I dislike ROI as an indicator I prefer the dollar results and here they are.

75-cent gainers up market: -$2.16 (-14.81% ROI)
75-cent gainers down market: -$60.23 (-355%)
75-cent losers up market: $20.77 (55%)
75-cent losers down market: -$178.07 (-450%)

Pretty conclusive stuff – the best long trades from start to finish are the dippers in an upward moving market. The best shorts are the dippers in the downward moving markets.

So it isn't "buy the dips sell the rips" but rather "buy the dips and sell the dips".


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