The High and Low Divergence Day Trading Strategy: An In-Depth Analysis

S&P 500 has historically a strong tendency to revert to the mean. I’m looking to find a way to fade the gap. My research has indicated that fading the gap is best after a strong move in either direction.

Thus:

The high and low divergence day trading strategy

Here are the criteria for a reasonable solid fade the gap strategy:

1. Calculate a 25 day average of the (High minus Low). That is the “ATR“.
2. Calculate the Low of the last 10 days.
3. Calculate the (C-L)/(H-L) ratio every day (IBS).
4. Calculate a band 2.5 times above the 10 day low using the average from point number 1 (ATR).
5. If SPY closes above the band in number 4, and point 3 has a higher value than 0.85, there might be a fade the gap trade tomorrow (short side).
6. If SPY opens up more than 0.1% the next day, go short at the open and hold until close.

Reverse all this for long trades, except for point 5: There are significantly fewer trades on the long side, and this number can be set to 0.25.

There is no target or stop-loss. Using a target just set a stop in the profits.

Now, this might have been better formulated. I hope the readers understand the strategy.

Here are the numbers from 2005 until October 2012:

As you can see from the numbers the win ratio is not fantastic. I have fade the gap strategies that have a much better win-ratio. But the best part is that this simple strategy has a high number of very big winners. And I’m using only open and close so it should not be any big errors in the quotes (from Yahoo!finance). I  have traded a twist to this strategy before with success, but this one looks better. The bigger the gap, the better it works. And the more volatile move before, the better, so this can probably be improved.

And the equity curve (blue line is long and the pink line is short):

This works reasonably well. There are big winners and the losers are quite moderate. Even removing the big winners the average is quite good. The good thing is that short is actually better than long, something which is rare.

This strategy does not work holding overnight.

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FAQ:

– What are the key criteria for the high and low divergence day trading strategy?

The strategy involves several criteria, including calculating a 25-day average of the high-minus-low range (ATR), determining the low of the last 10 days, computing the (Close-Low)/(High-Low) ratio daily (IBS), and establishing a band 2.5 times above the 10-day low using the ATR. Trades are considered when SPY closes above the band with a high IBS value for short positions and the reverse for long positions.

– What time frame does this strategy cover, and what is the historical performance?

The strategy’s historical performance is assessed from 2005 until October 2012, primarily focused on short and long trades in the S&P 500 (SPY). While the win ratio isn’t exceptional, the strategy yields significant big winners, particularly after substantial gaps and volatile moves.

– What is the primary advantage of the high and low divergence day trading strategy?

The strategy’s main advantage is its ability to deliver a high number of substantial big winners, even though the win ratio may not be outstanding. It works well, especially with bigger gaps and more volatile market movements.