Improving The Double Seven Strategy

July 14, 2014 5:00 am19 commentsViews: 4134

In this article I want to take a look at a reader’s recommendation on improving the Double Seven strategy. If you recall, the Double Seven strategy is a long-only strategy for the the broad U.S. indexes. It was created by Larry Connors and was covered in a previous article, “Double Seven Strategy”. Recently a reader pointed out a possible improvement to the system which appeared in the “Letters to the Editor” section of Stocks & Commodities Magazine, V. 27:3 (8-9). In short, the recommendation modified the entry and exit signals in an attempt to capture more profit. Changes included the following:  Market entry would become a buy stop entry and the exit would become a trailing stop. To be honest, I found the description of the changes not 100% clear and my testing was not promising. However, the concept of a buy stop and trailing stop are worth looking into. First, let’s provide a quick review of the Double Seven strategy.

The Original Rules

As a reminder, here are the original rules for taking long trades which are executed on a daily chart:

  • The instrument must be above its 200 day moving average
  • If the instrument closes at a seven-day low then buy at market
  • If a long position is open and the instrument closes at a seven-day high then sell at market

Testing Environment

I coded the above rules in EasyLanguage and tested it on the S&P cash market going back to 1983. Before getting into the details of the results let me say this: all the tests within this article are going to use the following assumptions:

  • Starting account size of $100,000.
  • Dates tested are from 1983 through June 30, 2014.
  • The number of shares traded will be based on volatility estimation and risking no more than $2,000 per trade.
  • Volatility is estimated with a five times 10-day ATR calculation. This is done to normalize the amount of risk per trade.
  • The P&L is not accumulated to the starting equity.
  • There are no deductions for commissions and slippage.
  • There are no stops.

Please note we are not adding our profits to our trading account! We are always trading a small percentage of our starting capital. Thus, the results demonstrated here are very conservative and it would be easy to generate much higher returns. Here is the position sizing formula used:

Shares = $2,000 per trade / 5 * ATR(10)

For an example of what the trades will look like on a daily chart, below is an image of a couple of trades. As the market makes a seven-day low, a long trade is entered. Open trades are then closed at the next seven-day high.

Double_7_Chart_Example_Trades

Double Seven Results

Based upon the standard rules we get the following results trading the S&P cash market.

Double 7 Results

Double Seven Equity Curve

Modification of Entry Signal

The recommendation within Stocks & Commodities Magazine recommended…

“Set a sell-stop 0.1 below the close of the seven-day high, and keep moving it below the close each day until you are sold out.”

I modified this a bit. In essence, we have a classic trailing stop and it makes a lot of sense given we are attempting to capture as much profit as possible when the market recovers from a pull-back in an overall bullish regime. Presumably during a strong market we can expect price to occasionally go beyond our traditional seven-day high exit. A trailing stop may very well capture more profit. Of course some of the trades will “give back” some of the profit as price must fall to hit our seven-day stop, but the handful of runners should provide us with more P&L to offset these setbacks. The only way to really see if this will work is to test it. For my test I used the seven-day low instead of the close.  Below are the results with our new modified seven-day low trailing exit.

Double 7 Trailing Stop

Trailing Exit Equity Curve

We can see we make slightly more net profit but it comes at a price. Our profit factor falls as does the percentage of winning trades. We decrease our consecutive winners while increasing the number of consecutive losing trades. We do have a slightly larger average profit per trade, but we obtain this with less efficiency as seen by our profit factor. Viewing the equity curve you can clearly see the choppiness of this system. Sure it makes more money, but it’s not a clean looking equity curve when compared to our standard Double Seven Strategy. Why would this be? By introducing our trailing stop we are causing a number of trades to get stopped out that ultimately turn in our favor. This leads to more trades when compared to the original rules as well. Recall the original rules have no hard stop – only dynamic exit at a new seven-day high. By adding our trailing stop we immediately place a hard stop at the low of the past seven-days. Introducing this stop ‘hurts’ our system. Can we try something else? Maybe what we can try is only introducing the trailing stop when…

  1. a new seven-day occurs; and
  2. we have positive P&L.

This will delay adding the trailing stop. Price will be free to meander or make new lows instead of taking us out at a nearby stop level. If price happens to move lower before we add our trailing stop then makes a new seven-day high and our open position P&L is negative, we’ll call this a losing trade and simply exit at the market. However, if we have positive open position P&L at a seven-day high, we’ll activate our tailing stop. Below are the results.

Double 7 Tailing Stop on Profit

Trailing Exit Equity Curve on Positive P&L

This looks a lot better. We are making significantly more profit and doing it will decent efficiency based upon the profit factor value. We do take some significant heat based upon the drawdown value. Overall, the equity curve looks decent as we make more profit per trade.

Modification of Entry Signal

The recommendation within Stocks & Commodities Magazine recommended…

“Set a buy-stop 0.1 above the close of the seven-day low, and keep moving the buy-stop down above each day’s close until you are bought in.”

The idea is we can often enter at a lower price if the market continues to fall dramatically over the next day. I tested this with not much promise. To me, setting a buy-stop at a level .01 above the close of the bar does not make a lot of sense. Often when setting a buy stop to enter the market you set it above a recent significant high. What comes to mind is the daily high. So, that’s what I did next. When the market markets a new seven-day low, I then place a buy-stop at the high of the bar. Price must then hit that high in order for a new position to be opened, confirming some strength on the bullish side. Please note, we are adding these new entry rules but keeping our original exit. This is because I want to see how these new rules changes the system without the interference of our new exit.

New Entry Signal Equity Curve on Positive P&L

This significantly reduced profitability. Clearly, buying into the weakness is better than waiting for bullish confirmation. While it may “feel better” to wait for bullish confirmation before opening a long trade, the performance metrics clearly state you should be buying into weakness. In short, the original rules produce much better results.

Conclusion

This experiment was not really a test based upon the rules provided by the Stocks & Commodities Magazine reader. However, it was inspired by it. Thus, it’s possible the reader’s solution may be better than what I’ve come up with here. I really don’t know. However, I think we can see some basic tenants of trading the S&P during a bull market that many readers of this website will be familiar with.

  1. Buy into weakness with a market order.
  2. Hold a trade to gain more profit.

These are well known tenants of the S&P and this strategy test just highlighted them once again. Other things that could be tested include buying with limit orders and exiting into strength based upon a different indicator such as a 2-period RSI. In closing, we found that our best results were realized by only modifying our exit rule to include a trailing stop.

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Jeff is the founder of System Trader Success – an inBox magazine dedicated to sharing great ideas and concepts from the world of automated trading systems. Read More Google

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19 Comments

  • BlueHorseshoe

    One advantage of the RSI(2) over this strategy is that the RSI has time decay built into its formula.

    Consider a long position that goes against you . . .

    The harder the market continues to fall, the LESS it will then need to rise in order for the RSI to cause an exit.

    When in the same situation with the Double Seven strategy, the harder the market falls, the MORE it will need to rise in order to exceed prior closes and cause an exit.

    So, with the RSI approach, the assumption that the greater the period of time you’re trapped in a losing position the less likely it is to show a significant profit is built in.

    To do something similar with the Double Seven, you could introduce a rule along the lines of “For each additional day the position is open, the number of days for which the high/low must be exceeded in order to trigger an exit is decreased by one.” After 7 days in a position, only a single higher high or lower low would be needed to exit.

    The RSI seems a much more straightforward way of achieving this though?

  • BlueHorseshoe

    Something like this would be interesting:

    If c=highest(c,(7-barssinceentry)) then
    sell this bar;

    If c=lowest(c,(7-barssinceentry)) then
    buytocover this bar;

  • Hi Jeff,

    I have a basic question concerning buy orders. In this system (for most other systems it’s also true), you get follow up signals if price is going down for more than 7 days. Should one still buy as long as price drops or will you stop buying after the signal until the position is closed? I wonder because I’m implementing the double seven system into a home brew backtesting app and encountered big drawdowns in the account due to big position build up – but it stills seems to profit.

    Niels

    • If I understand you correctly Niels, I think you’re talking about placing multiple buy orders. If this is true then that’s not how the system was tested. Once a position is opened all further buy signals are ignored. It’s only when your account is flat can a buy order be placed.

      • Thanks. That was exactly what I wanted to know.
        Great website by the way. I’m learning a lot.

  • Here are the results from the exits recommended by BlueHorseshoe. The two-period RSI exit works nice with this system as well. In terms of pure profit, the trailing stop captures more of it at a cost of more losing trades. The RSI exit does provide you with a higher percentage of winners, but less net profit. It seems the original Double 7 system is a nice compromise between the trailing exits and RSI exits. In short, all of the exits “work”, but the question is, what’s right for you?Bluehoreshoe-Results

  • Great site Jeff, thank you for sharing your work. Question for you: In your opinion, is there an RSI(2) parameter that would be viable for an end of day (EOD) only trader, with very next trading day exit? In general, have you come across any viable L/S strategy ideas for very next trading day direction, using EOD only trades? Thanks in advance.

    • Thanks for the kind words Jim. I think the RSI(2) can be used by EOD traders. If you are looking to for ideas for trading the next days direction using end-of-day data, many of the Larry Connors strategy ideas could be used as a starting point.

  • Hi Jeff, Congratulations for the great website! I like the Connors approach to the markets. I See various articles with Connors systems but all are very similar (the systems , not the articles)and it is impossible use various at the same time. Do you use any system with real money? If you need to pick one, which one do you choose? Thanks!

    • Thanks Jonatan. I do trade Connors based setups with real money. The RSI(2), RSI-TRIN, and RSI(2) Accumulation are all setups I use. I use these signals on daily charts and then zoom in to a 5-minute chart to pinpoint entries. I’ve been doing this for several years with success. I think there are others that are worth pursuing but these are the ones I use currently.

  • Interesting Article. How do you claculate your stop? Thank You.

  • This is probably a silly question but if your max position size is 2K then how does the system get 7K+ of drawdowns?

    • Hello Johnathen. Remember the 2K max position size is per trade. If you have three consecutive trades that hit the stop loss of $2,000 then you are already down $6,000. If on the next trade you exit at a $1,000 loss you now have a 7K drawdown.

      • I assume you are applying some leverage so? Otherwise the only way you could loss the a full 2k trade is if the instruments value goes to zero.

        Also your oringinal test says there are no stops so how do you position size in that case?

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