The High And Low Divergence Day Trading Strategy

Last Updated on June 19, 2022 by Quantified Trading

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:

% #trades #wins Avg
Long 18.64 44 25 0.42
Short 20.09 72 43 0.28

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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  • Historically speaking in regards to the S&P500, it is rare for the SPY to ralley consectively like what we have seen this jan. Reason being is because the majority of the gains in the S&P500 are made in the overnight session. I strongly agree that the SPY/ES hold strong mean reversion properties which is probably why this strategy works a lot better on the short side than the long side.

    Oddmund,

    I was reviewing your post in regards trading GDX. I was doing a back test on Gold futures and in the backtest, the price spikes around 8am/9am American time and then drops. Is there any fundamental reason why this might occur? Is there a significant imbalance that takes place when the american markets open ? For the month of january if you shorted GDX from the open and sold by 10am you would of made money 20/20 times!

  • How are you handling the logic of your system referencing the open, since it’s not possible to enter an opening auction order *after* you know the opening price is up .1% as you suggest? Or are you using intraday data and the system actually trades @ 9:31 NY time? Same problem would exist for closing orders except with a longer time window for entering MOC orders.

    Love your blog. Keep up the good work!

    • Hi,

      SPY is heaviliy traded and I know if it’s gonna open up .1% two mins before open. Sometimes it’s just around 0.1% and that is a problem, but generelly not. I use OPG oders.

      As for MOC orders I always use my indicators system at around 15.35 NY time.

  • YOU ARE BRILLIANT!
    I TESTED IT ON THE SHORT SIDE AND GET 69 TRADES.
    Could you tell me what’s the meaning of the number blow “%”;
    and how do you calculate the “avg”?

    I summed all the P&L with a final value 23.4203%

  • for the long side; Is the following steps right?
    step 1-do we need to calculate the low -high average(ATR)?
    step 2-calculate the highest of the last 10 days
    step 3- IBS (same)
    step 4- spy close below the lower bond (10 day high -2.5 *the ATR ) and IBS <0.25
    step 5- spy open down 0.1%,long it