Monday, April 27, 2009

Shooting Star - SPY Tested

Several sources today were citing the bearish implications that a 'shooting star' may have.

A shooting star is defined as: A single day pattern that can appear in an uptrend. It opens higher, trades much higher, then closes near its open. It looks just like the Inverted Hammer except that it is bearish.

Of course, we opened lower but we did trade much higher from where we opened. And it did close near its open. While this doesn't fit the description of a shooting star, the pattern still looks similar and I wanted to test its significance. It seems like it would suggest a rejection of higher prices which should lead to lower prices. So let's test that.

The criteria I used for my test was as follows:
1. The close has to be in the bottom 25% of the day's range.
2. The day's range has to be at least 4 x greater than the difference between the open and close. This results in a long 'shadow' and a small 'body'.
3. It sells tomorrow's close (1 day was used but 2, 3, 4, or 5 days didn't help)

Tested over a 5, 10, or 15 year period, this criteria provided almost NO edge whatsoever. It had a net profit close to $0 and won on average 50% of the time.

So all this shows is that with this criteria isolated is it virtually useless. If you'd like to incorporate this price pattern into your trading, you would obviously need to use this as a supplement to your entry criteria.

As a simple example, I used the criteria above but added the filter that the close had to be above its 10 day MA and under its 200 day MA. I just randomly picked these numbers but it does in fact describe the market's (SPY) current situation.

Under this new scenario it is actually profitable to buy the close. Granted it has only occurred 11 times since 1993 so I wouldn't consider this 'properly' backtested but it's just an example. Anyhoo, in this example, buying this scenario was profitable 91% of the time. See below - click to enlarge.

Equity Curve

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