Last Updated on November 11, 2022
There are certain trading strategies that you can trade based on price action alone. One of them is the HHLL trading strategy. You may be wondering what the HHLL trading strategy is. Here you go:
The HHLL trading strategy is a price action (based on price movements) reversal strategy that involves buying an instrument after the price has made a lower low and a higher high in a downtrend and comes back to the initial low. Similarly, a selling opportunity arises when the price, in an uptrend, makes a higher high and a lower low and then comes back to the initial high.
In this post, you will get acquainted with the HHLL strategy. We make a backtest at the end of the article.
Let’s dive in.
What is the HHLL strategy?
The HHLL strategy is a price action reversal strategy; which means, it is based on studying the price movements and aims to spot the reversal of the trend. In an uptrend, it seeks to spot a selling opportunity, while in a downtrend, it aims to spot a buying opportunity.
The strategy involves buying an instrument after the price, in a downtrend, has made a lower low and a higher high and comes back to the initial low. Similarly, it spots a selling opportunity when the price, in an uptrend, makes a higher high and a lower low and then comes back to the initial high.
To understand the strategy, you need to understand how to use price swings to read the direction of the trend. To have an uptrend (bullish trend), there should be a series of higher swing highs and higher swing lows. On the other hand, a downtrend (bearish trend) consists of a series of lower swing lows and lower swing highs. The HHLL strategy tries to spot when that series is broken, indicating a potential trend reversal.
For the short term, several lower lows usually mean an opposite reaction is imminent, while several higher highs might signal a short-term top. Please read our take on this:
- Lower highs and lower lows pattern (trading strategy)
- Higher highs and higher lows pattern (trading strategy)
As you can infer from our explanations so far, HHLL means higher high and lower low. For example, let’s say we have an uptrend that got to a high (H), then followed by a correction to a low (L). After that, the price makes a higher high (HH), and then we notice a breakdown of the trend structure, with the price making a lower low (LL), we will begin to think of a potential trend (bearish) reversal.
Here is an example of the HHLL pattern:
The entry rule for a buy trade would be as follows:
After the price makes the lower low (LL), signifying an impulse wave in the downward direction, expect a pullback to the previous high (H). That is where to enter a sell order (or short order):
Similarly, let’s say we have a downtrend that got to a low (L), then followed by a correction to a high (H). After that, the price makes a lower low (LL), and then we notice a breakdown of the downtrend structure, with the price making a higher high (LL), we will begin to think of a potential bullish reversal.
After the price makes the higher high (HH), signifying an impulse wave in the new direction, expect a pullback to the previous low (L). That is where to enter a buy order.
An example of the HHLL indicator
HHLL trading strategy (backtest and example)
We have mentioned the Zig Zag indicator, but unfortunately, that indicator uses forward-looking elements, and thus it’s not suitable for backtesting or trading.
It’s very difficult to backtest the HHLL strategy with strict trading rules and settings. The reason for that is the element of discretion when it comes to reading the tops and bottoms. Any quantified backtest would need to rely on many rules, and this complicates things – a lot.
That said, the HH and LL constitute what is called an outside day:
Let’s make a simplified version of the HHLL strategy. We make the following trading rules for our backtest:
- Yesterday was an outside day.
- Today is a down day, meaning the close is lower than yesterday.
- If 1 and 2 are true, then go long at the close.
- Exit after ten trading days.
Let’s backtest on Philip Morris (PM), a tobacco sin stock. This is what the equity curve looks like:
After some troubles during the financial crisis in 2008/09, the strategy performed pretty well. One reason for that might be that PM is a “recession-proof” stock and one that is among the least correlated to the overall market (S&P 500). Additionally, because Philip Morris is quoted and reports in USD but has practically zero income in USD (all sales are non-US after the split with Altria – MO), it’s dependent on the USD rate. Thus, it behaves a bit differently than most other stocks.
The HHLL trading strategy backtest has 118 trades, CAGR is 9.8%, the average gain per trade is 1.26%, and the profit factor is 2.2.
HHLL trading strategy backtest code
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