The 3-Day Down Overnight Trading Strategy In The S&P 500 (3 Down Days – And Gap Up?)

Last Updated on January 31, 2023

Here is a simple mean reversion twist in SPY that holds the S&P 500 just one day (from the close to the next day’s open). It’s an overnight trading strategy, the lowest-hanging fruit in the stock market.

This article was initially published in 2013, ten years ago, and it’s about time we updated it.

The 3-day down overnight trading strategy

In plain English, the strategy reads like this:

1. SPY must be down three days in a row (from close to close).
2. Entry on close on the 3rd down day.
3. Exit the next day open.

Here is the equity curve from 2005 until the present (the pink line is for short but uses 4 up days and then goes short):

There are 200 fills for long and a respectable 0.18% gain per fill.

Let’s backtest the strategy in Amibroker. Again, we backtest SPY, but this time from 1993 until February 2023:

There are 643 trades, and the average gain per trade is 0.13%. This might not sound much, but in a liquid asset like SPY, this is tradeable even though slippage and commissions are not included in the backtest.

The win rate is 65%, and max drawdown is 8%.

Let’s change the rules and exit on the close instead of the open:

Exiting on the close the next day is even better: the average gain increases to 0.24%! The drawback is that the win rate drops to 60%, and max drawdown increases substantially to 17%. The CAGR is almost 5% despite spending just 8% of the time in the market.

Can the strategy be further improved?

Yes, in our Monthly Trading Edge for March 2022, we made a modified version of the strategy above that returned the following equity curve (less time in the market and smaller drawdowns):

• No. of trades: 404
• Average gain per trade: 0.35% (1.35% for winners and -1.15% for losers)
• Win ratio: 60%
• Profit factor: 1.78
• CAGR: 4.6% (assuming no leverage)
• Exposure/time in the market: 5%
• Max. drawdown: -10%

In the bear market of 2022 (out of sample), the strategy made 35 trades and the average gain was 0.3%.

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