Everyone here knows that I’m a fan of the dumbest possible strategy. The less complex that rules are, the easier it is to understand when something inevitably breaks.
The SPY and Doji strategy from paststat most certainly fits the bill. The SPY is the ETF that tracks the S&P 500 index.
They tested a simple idea: does a doji on the SPY contain any predictive value? The short answer is a qualified yes.
The dojis offered no predictive value on their own. However, teaming them up with a 200 period moving average showed much better results. Use the location above or below the moving average showed a clear relationship between profit and loss.
So am I not touting this to all my readers? The biggest problem with a strategy like this is the sample size: there are only 40 trades in the largest sample. Some of the posted results only analyze the outcomes of 12 trades. That’s not a strategy. It’s hardly an observation, either.
What I do like about the idea is that it hightlights something fundamental about how the stock market works. I always think of it as a pair trade. You buy 1 unit of stock for every X dollars of currency.
You’re really pair trading two asset classes: one is a stock, the other is dollars. The flow of the forex market dominates stocks. A surge in dollar strength almost certainly anticipates a down day in stocks.
The fits and starts of the forex market lead stocks to crawl their way upward. Bull markets last for years and years. Unless you’re counting Fed days, there’s no particular move that dominates in stocks.
SPY Strategy Idea
Contrast that with bear moves and the difference is night and day. Everyone knows about the 1987 crash when the market crashed 22% in a single day. Our more recent crisis in 2008 inflicted similar damage over a period of weeks.
Price crossing the moving average is one of my favorite strategies. It’s dummy proof and I’ve seen it work in several markets, especially forex commodity crosses.
The SMA filter that paststat applied in the doji strategy might just make for a better daily trading strategy altogether. I’d even be tempted to ignore the long trades and take short only signals. A simple filter like the put-call ratio might help filter out the worst of the noise trades.
What I like even more is that it’s a strategy that could apply in today’s market:
- The stock market is trading on record margins of debt
- Selling the idea of a crisis isn’t hard with the potential US default looming
We’ll have to take a look at this in more detail tomorrow.