Sunday, June 15, 2008

Limit Orders and Performance

End-of-day traders can often feel at a disadvantage to their day-trading colleagues, even when trading a system developed with EOD data and designed for EOD trading. This week I wanted to try and determine what kind of advantages might exist for the intraday trader with the breakout system we have been developing and look at some ways the EOD trader might still take advantage of them.

Using our latest standard entries and exits listed below, I began with a basic data mining exercise probing specifically around the day of, and day following our entry signal, all still with the use of OHLC data. The following statistics are averaged between all three of our standard test portfolios.

% of Close to Close Winners: 49.43%
% of Open to Close Winners: 49.27%
% of Overnight Gap Ups: 41.88%
% of Overnight Gap Ups that don't fill the following day: 10.65%
Average Overnight Gap: 0.02%
Average Close to Close Return: 0.18%
Average Open to Close Return: 0.17%

At first look, these results do seem to offer a slight edge to the intraday trader who can place orders before the market closes on the Entry Signal Day (ESD). However, 89.35% of these stocks do retrace back below the close so the next step was to take a closer look at these.

The method I decided to use for this was to calculate the difference in price (Close-Open) on the ESD and then use a percentage of that to determine what percentage of stocks had a low below that point the following day. For example, if a stock had an ESD open of $40 and an ESD close of $46, the total ESD price change was $6. A 50% retracement would mean the stock had a low the following day below $43. The percentage of stocks hitting these retracement points were as follows:

5% 81.71%
10% 73.71%
15% 64.66%
20% 55.31%
25% 46.58%
30% 38.61%
35% 31.59%
40% 25.09%
45% 20.24%
50% 15.73%
55% 11.95%
60% 9.03%
65% 7.04%
70% 5.27%
75% 4.57%
80% 3.86%
85% 3.34%
90% 2.89%
95% 2.23%
100% 1.84%

What I gathered from this was that the use of a limit order rather than a market order at some retracement point below the ESD close may offer enough of a price advantage to increase expectancy and provide the EOD trader with a technique to level the playing field a bit with their intraday colleagues.
As usual, we will run the test on three separate portfolios to increase our confidence that the results are systemic and all tests will be run from 01/01/1998-12/31/2007. Other than the use of limit orders at the various retracement points, the entries and exits are identical to the ones used in the past several weeks:

10-day average daily volume >= 100,000 shares
200% volume increase over 10-day average daily volume
2x ATR breakout (Close >= Yesterday’s close + 10-day ATR*2)
8% fixed protective stop (GTC stop order)
20% fixed profit target (GTC limit order)

In the following graphs, I have also indicated the performance level for the corresponding market order for easy comparison, identified by the thin horizontal line. The performance criteria are as follows:

PF=Profit Factor. This ratio is derived simply by dividing gross profit by gross loss.

EDR=Expectancy per dollar risked. It is calculated by Average Trade/Average Loss. The results are in dollars with .60 representing 60 cents per dollar risk.

EER=Efficient Expectancy Ratio. This is our EDR/Avg. Days in Winning trades. This number is meant to reveal the most efficient use if capital as it calculates expectancy per dollar risk per day in trade. The results are in dollars with .01 representing 1 cent per dollar risk per day in trade.

Although the results are not as smooth as we would like, what is important to note that in almost all instances, the use of a limit order outperformed that of a market order. As indicated in the raw data below, the number of trade opportunities diminishes rather quickly as the retracement level requirement increases but the use of a small 10% retracement increased our Avg Trade and EDR by 19.1% on our Nasdaq portfolio, 9.4% on the IBD portfolio, and 13.8% on the S&P portfolio.

It is also interesting that the higher retracement levels have a pretty clear bias towards higher trade efficiency as shown in the EER graph resulting from the fewer average days winning trades are held. Perhaps most ironic is that the use of a limit order instead of a market order improved expectancy by over 3x what the use of the infamous moving averages did in last week’s tests.

The conclusion here is that there is really no need to chase these. The likelihood of at least a small retracement the day following an entry signal is high and waiting on that better price can offer a rewarding increase in expectancy. Furthermore, the use of limit orders at predefined levels allows the EOD trader to place these outside of market hours and still capture some of the price advantages typically reserved for intraday traders with the added advantage of reducing or eliminating entry price slippage.

1 comment:

Woodshedder said...

Very cool. Makes this trader, who is unable to trade during the day (most days) very happy!