Larry Connors’ R3 Strategy (It Still Works) | Trading Strategies Explained
Today we test Larry Connors‘ R3 strategy and we continue backtesting the trading strategies Larry Connors and his team published in 2009 in a book called High Probability ETF Trading. All the strategies were tested on a basket of 20 liquid ETFs. The previous articles can be found on our page containing many different quantified trading strategies:
Here you can find all our Larry Connors Trading Strategies.
12 years have passed since the book was published and it could be interesting to know if Larry Connors’ trading strategies are still performing well.
Today, we look at Larry Connors RSI trading strategy in chapter 4: The R3 Strategy (Larry Connors RSI 2):
Key takeaways
- The R3 strategy is a mean-reversion trading system published in Chapter 4 of Connors’ book High Probability ETF Trading (2009).
- It uses the 2-day RSI (relative strength index) as its main trigger.
- Entry conditions include being in a favourable environment (for example the close being above the 200-day moving average) and then a sequence of RSI drops: three consecutive days where the 2-day RSI falls, with the first drop coming from a value below 60, and then entering when the 2-day RSI is below 10. Exit is triggered when the 2-day RSI rises above 70.
- There is also an “aggressive version” (which Connors proposed) where when the position goes below the entry you add a second unit—but the article does not test this version.
The trading rules of R3
The trading rules are pretty simple:
Trading Rules
- The close must be above the 200-day moving average.
- The 2-day RSI drops three days in a row and the first day’s drop is from a reading below 60.
- The 2-day RSI is today below 10.
- If number 1 to 3 is true, then enter at today’s close.
- Exit on today’s close if the 2-day RSI is above 70.
These are all the rules to Connors RSI strategy, and the formula is pretty simple. Connors added an aggressive version as well: Whenever the position closes below your entry point, add a second unit. We will not test the aggressive version in this article.
The code in Amibroker
If you like to know the code of Connors’ strategy plus the code for all the other free strategies on this website, click here (Connors has also used Amibroker extensively):
For more on why we use Amibroker, you might want to read this article:
The results of R3
We tested the strategy on the data used by Connors. Unfortunately, we didn’t manage to replicate the results 100%: we got fewer fills. Both Connors and we tested on dividend-adjusted data sets, so we are not sure why our results differ slightly.
Anyway, the table below summarizes both Connors’ and our results. Our results cover the whole period the ETF has been listed (since inception) until December 2020 (no commissions and slippage included):
| Result by Connors | The average gain since | Profit | ||||
| The average gain in % | inception to Nov.2020 | factor | Difference: | |||
| DIA | 0.17 | 0.65 | 2.48 | 0.48 | ||
| EEM | 0.91 | 0.45 | 1.4 | -0.46 | ||
| EFA | 0.85 | 1.13 | 6.34 | 0.28 | ||
| EWH | 1.18 | 0.31 | 1.17 | -0.87 | ||
| EWJ | 0.9 | 0.51 | 1.78 | -0.39 | ||
| EWT | 0.85 | 0.31 | 1.29 | -0.54 | ||
| EWZ | 1.94 | 1.99 | 4.83 | 0.05 | ||
| FXI | 1.19 | 1.32 | 2.98 | 0.13 | ||
| GLD | 1.08 | 0.76 | 2.54 | -0.32 | ||
| ILF | 1.78 | 1.77 | 6.17 | -0.01 | ||
| IWM | 1 | 0.74 | 2.23 | -0.26 | ||
| IYR | 0.17 | 0.45 | 1.67 | 0.28 | ||
| QQQ | 1.24 | 1.04 | 2.46 | -0.2 | ||
| SPY | 1.16 | 1.28 | 7.17 | 0.12 | ||
| XHB | 0.22 | 1.99 | 9.53 | 1.77 | ||
| XLB | 0.24 | 0.42 | 1.54 | 0.18 | ||
| XLE | 1.2 | 0.72 | 1.77 | -0.48 | ||
| XLF | 0.46 | 0.26 | 1.11 | -0.2 | ||
| XLI | 0.8 | 1.02 | 2.89 | 0.22 | ||
| XLV | 0.63 | 0.63 | 2.46 | 0 | ||
| ETFs not | ||||||
| included in
Connors tests: | ||||||
| GDX | 1.68 | 3.11 | ||||
| GDXJ | 2.66 | 6.69 | ||||
| TLT | 0.13 | 1.24 | ||||
| XLP | 0.44 | 2.38 | ||||
| XME | 0.97 | 1.86 |
About 50% of the strategies performed worse in the last 12 years. The five ETFs at the bottom of the test were not part of Connors’ test, but we added them nevertheless (GDX, GDXJ, TLT, XLP, and XME).
The equity curve for the S&P 500 looks like this (SPY, compounded, 1993 until today):
The win ratio for SPY is 90%, but there are only 96 trades since 1993.
For the Nasdaq (QQQ), it looks like this:
How does the R3 perform as a portfolio on all ETFs?
One thing is to test a strategy on one ETF at a time, but more importantly, might be to test it as a portfolio on different ETFs.
Let’s simulate the results for all 25 ETFs from 2000 to December 2020. The buy and sell criteria remain the same as above, but we limit the number of open positions to a maximum of five at any time and the maximum equity allocation for each position to 20%. The equity curve looks like this:
The number of trades is 992, the win-ratio is 75%, the average gain per trade is 0.68%, and the profit factor is 2.08. The sovereign debt crisis in 2011 hit the portfolio hard, and the maximum drawdown was during August 2011: -16%. CAGR is 6.47%.
All in all, we would say the strategy performed well, and obviously, this strategy doesn’t fit all markets.
The R3 strategy on Nasdaq and the S&P 500 as a portfolio
Most traders are interested in how it performs on the Nasdaq and the S&P 500. Below is the equity curve with 50% of the equity allocated to each trade in QQQ or SPY (can hold 1 or 2 positions at any time):
The profit factor is high, 3,37, but the CAGR is a low 2.69%. The latter is a result of the low time spent in the market: 4.5%.
Larry Connors’ other trading strategies
Here you can find all our Larry Connors Trading Strategies.
Conclusion:
The R3 strategy is still working, 12 years after its inception. This is a mean reversion strategy and works best on equity markets.
We believe the strategy can be improved with a few minor adjustments.
FAQ:
What is Larry Connors’ R3 strategy, and how does it work?
Larry Connors’ R3 strategy, featured in Chapter 4 of his book “High Probability ETF Trading,” is a mean-reversion strategy. The trading rules involve conditions like the close being above the 200-day moving average, the 2-day RSI dropping three consecutive days with the first day’s drop from a reading below 60, and entering if the 2-day RSI is below 10.
What are the key trading rules of Larry Connors’ R3 strategy?
The key rules include the close being above the 200-day moving average, a three-day consecutive drop in the 2-day RSI with the first day’s drop from a reading below 60, and entering if the 2-day RSI is below 10. Exit occurs if the 2-day RSI is above 70.
What is the equity curve for the R3 strategy when applied to all ETFs as a portfolio?
The equity curve for the R3 strategy applied to all 25 ETFs from 2000 to December 2020 shows positive performance. The number of trades, win ratio, average gain per trade, and profit factor are highlighted, with a maximum drawdown noted during the sovereign debt crisis in 2011.