Every trader ever hopes to find a system that generates consistent profits, with minimal risk. However, despite the staggering amount of systems out there, many traders are unable to determine which method will actually bring reliable, repeatable results. How do you make sure that you trade the pros and not the noise in the market?
Introducing here the Failed Bounce Trading Strategy we published on our website more than eight years ago. Today the strategy we are proposing targets short-term pullbacks and the reversals of the market. It has emerged as a tried and tested strategy which has faced the test of time.
Let’s walk you through the very basics of the Failed Bounce Trading Strategy which includes its trading rules, some real-life trade examples, and finally some backtested statistics. It is going to teach you how you can make use of this strategy to optimize your tracking of the movement in the market and boost your return.
What is the Failed Bounce Trading Strategy?
This “Failed Bounce Trading Strategy” takes its basis in using retracements of the market moves and price reversals. Define when the prices will no longer be sustained in their thrust up, then present the trading entries based on a pullback for this second sequence. In fact, since the early 1980s, this has been one of the most common trading strategies, especially when it would perform so much better in an extremely volatile market.
The nucleus of this strategy is the Internal Bar Strength indicator, used to find out just how strong a stock or asset is, by relating its current price range with the historical price range for the specified period. As far as the purposes of this strategy, values of IBS above 0.6 become sufficiently strong to cause a potential entry signal.
With that said, let’s dive down to the nitty-gritty trading rules the strategy above would adhere to:
Failed Bounce strategy rules
- IBS Indicator
Yesterday’s IBS must be at least 0.6 or higher. In other words, the stock is showing relative strength and will continue with its trend even after a short pull-back. - Low Condition
Yesterday’s low must be lower than the lowest low during the last five days. Thus, one can pick potential pullbacks that would take the price in a reversal direction. - Closing Condition Today’s close should be lower than yesterday’s close. That is, you can go long at a short-term correction; best time, theoretically before bounce back.
- Exit Condition
Out when near > yesterday high. This is the one single most important exit signal from the trading system. It happens at bottom short-term pull back and beginning of uptrend resumes.
Trade Examples: Real-World Application of the Failed Bounce Strategy
Let’s have a look at some examples of the trade. In each of these cases, we’re looking for a potential trade based on the conditions outlined above.
Example 1: Trade 1
- Signal: IBS is >0.6, low is lower than the previous five days’ lows and close <yesterday’s close.
- Trade: Enter at close.
- Exit: Next day, close >yesterday’s high.
Example 2: Trade 2
- Signal: Again, IBS was above 0.6, low was lower than previous lows, and close was lower than the previous close.
- Trade: Enter at the close.
- Exit: Next day when the price rises above the high of the previous day.
#### Example 3: Trade 3
- Signal: IBS was above 0.6 but the market did not show any bounce back from the pull back.
- Trade: Entry at close.
- Exit: When the price fails to travel further above the previous high brings the loss near.
Although this only reflected one losing trade, the bottom line is still a winner because of the higher win rate of the system.
Statistics of Trading for the Failed Bounce Strategy
We tested the Failed Bounce Trading Strategy on 204 trades to better see the strength of the effectiveness of the system:
Statistics:
Average Gain per Trade: 0.86%
Win Rate: 77% of the trades won
Net Profit: 450% return on investment
Yearly: 5.8% return, compound.
Time in Market: On average, invested only 8.5% of the time, with an otherwise 67% risk-adjusted return.
Achieving such high win percentages is exceptionally rare, and coupled with a very, very high risk-adjusted return, it is simply unthinkable to see. That is, it simply means that the strategy is very good at playing along with short-term market moves with minimal risk exposure.
Performance on Other Assets
So you’d ask me, “Does that strategy work with anything other than stocks?” The strategy was pretty good with stock-based ETFs, but it’s lagging with commodities or bonds. This method catches price action of equity-based ETFs like Pepsi Cola (PEP) or XLP (Consumer Staples ETF) much better because equity-based ETFs tend to be much more consistent in with trends.
This is only because most stock-based ETFs are extremely price-sensitive, and this could make their volatility quite higher than it would be compared with that of commodities or bonds. In volatile markets, pullbacks are more frequent, and hence, it gives reversal strategies a greater chance to perform much better.
Equity Curve of the Failed Bounce Strategy
Now, let’s see how this strategy really does graphically by looking at the equity curves of different assets going through this strategy:
Pepsi Cola (PEP) since 1976: The equity curve shows a smooth upward slope with minimal drawdowns. Graphically describes the strength of the strategy in emphasizing profit even within a downtrend and trend changes.
XLP (Consumer Staples ETF): It has performed similar to PEP. Consistency of profit in the long term leads the strategy profitable.
Among such assets, one of the best reliable strategies through which one can earn steady returns over time by minimizing his or her exposure to risk is the Failed Bounce Trading Strategy.
The Failed Bounce Trading Strategy worked well as a mechanism for extracting profitability in short-term reversals found in the marketplace. It is founded on a simple set of rules about the IBS indicator and price action, yet it has proven effective in backtesting and in real-world execution.
- High Win Rate: The win rate is at 77%. That is an enormously higher number to win than to lose.
- Low Market Exposure: This investment comes in only 8.5% of the time. Thus, it manages to keep the risk due to excessive market exposure at bay.
- Good Strong Profits: Even though the average outcome per trade happens to be as low as 0.60%, the consistent application of the rule delivers strong good profits.
Whether you trade individual stocks, equity-based ETF’s, or like to attack the Failed Bounce Strategy as part of a bigger portfolio, this strategy will give you a consistent route by which small pullbacks all become profitable.